When private companies are sold, the parties often sign a letter of intent to ensure that they agree to basic terms. Negotiating this document can save time and avoid wasted effort. Here’s what you need to know.
What is Included in a Letter of Intent?
A letter of intent (LOI) typically includes:
- Sale price
- Adjustments to the purchase price based on whether the deal will be cash, seller financed, etc.
- The structure of the transaction
- Timeline for due diligence and negotiations
- Escrow to secure the seller’s obligations and the length of time escrow will last
- A timeline for the period of exclusivity
- Details about access to key records so the buyer can undertake due diligence
- Scope of significant representations and warranties
- How third-party contracts and agreements with employees will be handled
- Each party’s confidentiality obligations
- How disputes will be handled
- Under what circumstances the agreement may be terminated
LOIs can be long or short-form. Longer form are more comprehensive and legally detailed. They hammer out key deal terms well in advance, but demand a lot of upfront effort. Short-form LOIs are easier to negotiate and set general deal terms, but offer less protection against a deal falling through because of a fundamental disagreement over key deal terms.
What Type of LOI is Best?
A long-form LOI is typically best for the seller. This is because once the letter is signed, leverage in negotiations transfers to the buyer. The more terms a seller can iron out ahead of time, the better. Buyers are more likely to offer concessions in a competitive bidding process—before the LOI is signed.
The buyer’s perspective is exactly the opposite. Buyers generally seek a short-form LOI with a long period of exclusivity. In most deals, the parties must ultimately balance these competing demands.
Binding or Non-Binding?
LOIs are not typically binding, or may be binding only for key provisions. In either scenario, the agreement must be clear about what is and is not binding. It’s common for terms such as confidentiality, deal exclusivity period, dispute resolution, and expenses to be binding.
An exclusivity period will be especially important to the buyer, since this gives the buyer time to undertake due diligence without fear that doing so might harm the deal.
Other Deal Terms
In addition to obvious factor like price, the LOI should also spell out other important terms, including:
- Whether stock is part of the deal
- The interest and principal payments associated with any promissory note
- Whether there will be a working capital adjustment
- Whether there will be an earnout, and what its terms will be
- Dates by which key deal steps should be completed
- The specific terms of any planned indemnification agreement
- A full and thorough disclosure schedule
- Conditions to closing
- Agreements about an escrow or closing agent