- in M&A Update
What is a Letter of Intent (LOI) in M&A?
The Letter of Intent (LOI) in M&A is a written, non-binding document which outlines an agreement in principle for the buyer to purchase the seller's business, stating the proposed price and terms. The mutually signed LOI is required before the buyer proceeds with the “due diligence” phase of acquisition. Besides detailing the price and payment terms of the transaction, the LOI includes items such as description of the assets to be purchased, any assumed liabilities, the terms of the seller’s non-compete agreement, the timeline for due diligence and closing, a confidentiality provision, and an exclusivity provision, commonly referred to as a “no shop clause.”
In a business sale transaction, there are usually three levels of discussion with prospective buyers before in depth due diligence commences.
The first level is a general discussion about overall revenue, earnings and the industry, without the buyer knowing the actual name of the business.
The second level begins if the buyer is truly interested and is qualified to purchase the business; they will then execute a Non-disclosure Agreement allowing them to receive a Confidential Business Memorandum (CBM), sometimes referred to as “the book,” with detailed information about the business. The CBM should include enough information about the business for the buyer to submit an indication of interest, which may lead to a meeting with the owner.
The third level begins with the buyer presenting, negotiating and reaching an agreement with the seller on the major terms of the transaction they are proposing, which is usually handled in a Letter of Intent (LOI) or Term Sheet. The Letter of Intent is a written, non- binding document which outlines an agreement in principle for the buyer to purchase the seller's business, stating the proposed price and terms. The mutually signed LOI is required before the buyer proceeds with the “due diligence” phase of acquisition.
The LOI used in M&A covers all non-binding preliminary agreements between the parties to the transaction.
Besides detailing the price and payment terms of the transaction, the LOI includes items such as description of the assets to be purchased, any assumed liabilities, the terms of the seller’s non-compete agreement, the timeline for due diligence and closing, a confidentiality provision, and an exclusivity provision, commonly referred to as a “no shop clause.” The LOI may also include some of the major terms to be included in the definitive agreement, such as limits on indemnifications to be made by the seller. The LOI is the template used in preparation of the final definitive purchase/sale agreement.
Negotiating the LOI confirms that there are many issues to clarify beyond just the price before allowing a buyer access to the inner works and confidential information of the business. In the final stages of the due diligence phase, the buyer may receive permission from the seller to contact vendors, customers and key employees and have access to very sensitive documents. Before allowing the buyer into this phase, an LOI needs to detail a specific timeline of whom and when they may be contacted.
The Letter of Intent is a roadmap for the buyer and seller during the due diligence process and becomes the outline for the purchase agreement.
The two main reasons to enter into an LOI are:
- Saving time and money by negotiating and putting in writing all the important terms of the transaction while minimizing misunderstandings and conflicts later in the process. Without having a basic understanding of all the terms of the transaction in an LOI, drafting a detailed purchase agreement can be lengthy and difficult. LOIs are usually are 6-8 pages in length whereas a purchase agreement is generally much longer.
- An experienced buyer will not spend considerable time and money proceeding into due diligence, analyzing all the information on the company, engaging CPA’s for tax advice and attorneys for drafting purchase documents unless they have an exclusive right to buy the company.
Our firm recently closed a transaction with an out-of-state buyer. The buyer’s first draft of the asset purchase agreement stated that the document would be governed by the laws of the buyer’s state. However, since the LOI said that “this document and all documents related to the transaction” would be governed by the laws of the State of Texas, this drafting mistake was quickly changed to agree to the LOI.
While the M&A professional will generally begin the LOI negotiation process and be integrally involved, the seller’s attorney should also be involved early in the process and review the final document. We have also noted that while the negotiation of the LOI is adversarial, once the LOI is signed, the two parties become more collaborative, as now both have their “deal” finalized and are looking forward to completing due diligence and proceeding to closing. A well drafted LOI will streamline the negotiation and document processes associated with a transaction and increase the probability of success.