A few years back, in my role as Corporate Development Director, I found myself in the middle of the most contentious letter of intent negotiations of my career. The sellers didn’t want to disclose the deal to employees until closing and they were concerned that due diligence would result in leaks. So the sellers insisted on a very detailed letter of intent before launching into due diligence. I spent several months negotiating that LOI and spent nearly as much on legal fees as I would on a purchase agreement. It was a long and frustrating experience, and not an approach I would recommend. That was one negative experience of many positive experiences using the LOI as a mechanism to move acquisition negotiations forward.
Laura’s first point out of the gates warning: if you’ve not had a M&A attorney review your LOI (or LOI template) wait to sign the document until you do. She once had a buy-side client who signed a letter of intent that had not been reviewed by her firm. The LOI contained binding purchase price language and the problem came during due diligence when the buyer asked for a reduction in purchase price due to DD findings. The seller pointed out that the price was already agreed in the LOI. While the seller could not force a deal based on the LOI, this oversight became a serious point of contention that caused the deal to break down. Not a problem I’ve encountered before, but good advice.
To keep the LOI simple, include these four sections—everything else is gravy—and remember, too much gravy is bad for your health:
Type of transaction
Are you proposing an asset or stock deal? The answer to this question has a substantial impact on taxation for the seller and, therefore, can impact purchase price.
When you get to purchase price, don’t forget a detailed description of what is being purchased. If its assets, identify the specific assets. Not just the tangible assets, but intangibles as well—you can use the “including, but not limited to” language. It is typical to indicate that the purchase price represents a debt-free amount (meaning the buyer acquires the company without debt). It is also typical to include language indicating that there will be a net working capital target and adjustments in the agreement. It’s usually too early to determine an appropriate NWC target, but it’s good to give the seller a heads up. Finally, you may want to include some language around the amount of cash up to be paid upon closing and then after closing related to escrow, earnouts, and holdbacks.
Standard representations and warranties
The idea here is to communicate that the agreement will include standard reps and warranties (or non-standard reps and warranties as I’ve experienced in the past). This is an area that if you get too detailed in the LOI, you can overwhelm the seller and get mired in legal negotiations before you’re ready (wait until due diligence to address reps and warranties specifically).
Exclusivity and confidentiality
Presumably you’ve already signed a confidentiality agreement to receive the company information needed to perform a valuation, so you may not need a confidentiality section in the LOI. Both Laura and I see typical exclusivity periods of 60 days, but this can vary greatly depending on the size and complexity of the transaction. Incidentally, exclusivity and confidentiality are often the only legally binding portions of a LOI.
One other consideration—If you’ve already crafted a term sheet, you may not need a letter of intent. You may just sign an exclusivity agreement and jump right to the purchase agreement. There’s certainly nothing wrong with skipping the LOI if you’re comfortable with the term sheet and both parties want to move quickly.
Laura has been kind enough to provide a few snippets of generic language often found in LOIs. I’ll include those at the end of this article, with the caveat that if you use any of this language as the basis for a LOI, you should have your attorney review it. This is not legal advice and the snippets are not a substitution for a fully-negotiated letter of intent.
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Type of Transaction and What is Being Purchased – We propose to acquire all of the assets of the seller, including, without limitation, equipment, office furniture, other tangible personal property, leases, contracts, intellectual property, accounts receivable (except those aged longer than 90 days), prepaid expenses and deposits, goodwill and other intangible assets, all of which shall be free and clear of all liens, claims and encumbrances.
What is Excluded – We will not assume or pay any debt of seller, except for debt associated with assumed leases and contracts. Seller is liable for all acts and omissions in the conduct of the business prior to the closing date and shall indemnify and hold harmless buyer for any liability (including any claim of successor liability) arising therefrom.
Purchase Price – The total purchase price shall be $_____. The purchase price includes $____ as consideration for the restrictive covenants. The purchase price is based on a value of the accounts receivable, inventory, work-in-progress and certain prepaid expenses, less current trade-related payables and accrued expenses of $_____. An adjustment to the purchase price may be made dollar for dollar for the actual value of these items as of the date of closing. There will be a holdback of $____ to cover the adjustment and the representation, warranty and indemnification obligations of seller.
Transaction Documents – The transaction documents will include a purchase agreement fulfilling the terms of this letter of intent and containing representations, warranties, opinions, terms, conditions, and indemnification obligations as are customary in connection with transactions of this type. We will require (1) a covenant-not-to-compete, for a period of ___ years following the closing, and a non-solicitation agreement, for a period of __ years following the closing, with each of ______ and _______; and (2) a consulting agreement with _____ for a period of ___ months following the closing for a fee of $____ per month.