The Letter of Intent or LOI is the cornerstone pre-contractual document given to the seller by the buyer that summarizes the understanding of how a transaction will occur as of the date of the LOI.
A Letter of Intent can also be called a Term Sheet, Memorandum of Understanding, or Agreement in Principle. No matter what it is called, the meaning is the same.
The LOI will describe what exactly is being purchased and the terms of the transaction.
The LOI is non-binding, meaning that is pre-contractual and is really just a way to move the transaction closer to a closing. Reaching the final closing of a transaction is almost always dependent on the successful completion of due diligence, which I talked about in another post.
Most transactions use an LOI as part of the process. It will come before the definitive and legally binding Purchase Agreement.
Stanley Foster Reed in his book “The Art of M&A” describes the LOI as follows:
“A Letter of Intent is a pre-contractual written instrument which defines the respective preliminary understandings of the parties about to engage in contractual negotiations. In most cases, such a letter is not intended to have a binding effect except for certain limited provisions. The Letter of Intent crystallizes in writing what has, up to that point, been oral negotiations between the parties about the basic terms of the transaction. While the Letter of Intent is usually non-binding, it does create a moral commitment and allows the buyer to proceed with the extensive due diligence process with a feeling of confidence. Conversely, the seller is required to withdraw the company from the marketplace and not discuss the potential sale with anyone else.”
There can be many items contained in a Letter of Intent or Term Sheet. Here is some of what you might see:
- The timing of the transaction. What is the proposed closing date? When will due diligence be finished?
- The structure of the acquisition, is it a stock sale or asset purchase? What is being included? How much of the purchase will be in cash? Any notes or seller’s financing?
- What is the price being offered?
- Closing costs and the responsibilities of both the buyer and the seller in the closing.
- Management contracts and their terms. Who will be remaining with the company and for how long? How are non-compete agreements going to be handled?
- How will confidentiality be handled during and after the LOI period.
- Brokerage fees: who pays and how?
- Representations and Warranties, this can change significantly during the due diligence process.
- Insurance – what will happen with existing policies?
- Due diligence items such as access to books and records, customers, vendors, and key employees.
- How to handle earnings that occur during the transaction process.
- Agreement for the seller to stop marketing the company during the time that the LOI is effective.
The Letter of Intent is a key document that you will likely see in almost every transaction. The signing of the LOI is the beginning of the buyer’s due diligence and is a very serious step towards completing the transaction. Though items in the LOI may be changed later, both sides will accept that the basic terms of the deal as laid out in that document.
As a seller, receiving an LOI is a big step toward selling the company. But the seller should not let their guard down and assume the deal is “done” at that point. Instead, keep moving the transaction forward until the Purchase Agreement is signed and the money (capital) has changed hands.
