6 Key Components of a Letter Of Intent

Letter Of Intent

by Terry Stidham, President of Target Search Group

There is a potential buyer that has expressed interest in your business, you feel that it might be a good fit and now this buyer wants more information. It's time to move to the next step via the letter of intent, or LOI. It’s important to understand that a letter of intent is not the end of the negotiation process but merely the beginning of formalizing it. A well-written letter of intent can reduce the potential for misunderstandings later and will get all of the parties’ assumptions and views on the critical terms of the deal on paper. A letter of intent is not, however, the actual agreement that governs the terms of the purchase, and in fact, if written properly is not an agreement at all.

Although LOI’s resemble written contracts, they are usually not binding on the parties in their entirety. Many LOI’s, however, contain provisions that are binding, such as non-disclosure agreements, covenants to negotiate in good faith, or "stand-still" or "no-shop" provisions promising exclusive rights to negotiate to the potential buyer. 

6 KEY COMPONENTS of a LETTER of INTENT

1. Clearly identify the document as a Letter of Intent - The document should make it clear that it is not a binding contract to buy or sell the business. The parties may want to include, and some states will impose automatically, a duty to negotiate in good faith. A good faith provision can be useful, especially for the seller, to prevent one party from using the negotiation and due diligence process solely to collect information about the other party and their business.
2. State from the outset whether the deal will involve the sale of stock or the sale of assets - It would be unfortunate if both sides spent significant amounts of money but one party thought from the outset that they were talking about a stock sale and the other party thought they were talking about an asset sale. If this point is not discussed from the very beginning, the deal could fall apart as the deal structure that is preferred by one party may not be feasible for the other party.
3. Include both a purchase price and an explanation of the assumptions that the purchase price is based upon - During the due diligence process, it may turn out that many of the early assumptions used in calculating the purchase price will turn out not to be true. If the method for calculating the purchase price is included in the letter, the parties have a road map on how the purchase price should be adjusted.
4. If the deal is an asset purchase then the parties should allocate the purchase price to the different assets on the acquisition target’s balance sheet - This allocation can have great effect on the tax implications of the deal for the parties. Since tax considerations are often critical to whether a deal is feasible, there needs to be a common understanding of purchase price allocations at a very early stage of the deal process.
5. The method of payment - As in point 2, if one party has in mind an all cash deal, and the other party has in mind a deal where the seller will hold onto a note or some other retained interest in the acquisition target, then it is a good idea for the parties to get on the same page from the outset, before either party has spent significant amounts of time and money on the deal.
6. All other major deal points - If either party has any other deal points that are crucial to them, they should let the other party know relatively early. Examples of these include: whether key employees must be retained for the deal to close, any expected non-compete agreements that the seller will sign, and if the buyer will be assuming any liabilities of the seller. Springing these on the other party late in the process may result in a failed deal after everybody has spent a lot of time and money.

The LOI is the entry point to the due diligence phase, where the buyer examines in varying degrees of detail, important trade secrets of the company. These may include customer lists, contracts, employee details, supplier agreements, etc. Because this information is so important, and in many cases, critical to your business, the  LOI serves to let only the  right buyers through the door.  Following successful completion of the due diligence phase, the LOI is replaced by the final purchase and sale agreement.

This article is for general information only. The information presented should not be construed to be formal legal advice nor the formation of a lawyer/client relationship.