What is a Letter of Intent, and Why Do I Need One?
The age-old question when it comes to buying and selling a business. A letter of intent or an LOI has big advantages to both parties when it comes to a business acquisition transaction. What does one look like, and do you actually need one?
First a business acquisitions letter of intent is a document that outlines some of the parts of a purchase deal that is not yet agreed upon and gives the buyer exclusive rights to make a purchase before anyone else is offered the business.
The reason for it is that it is often important and desirable for both parties to hash out at least some key terms before they go to the significant time and effort along with the legal expense and the use of other resources to pursue an acquisition. If the parties cannot agree to terms during the LOI phase, it is unlikely they will do so later in the negotiation process.
Types of Letters of Intent
First, there are two types of letters of intent. One is a short form, the other is a long form. In most instances, a buyer prefers a short form letter of intent with a long period of exclusivity that gives them time to do due diligence and perform other tasks. Usually they can get this if they have a lot of leverage in the negotiation process.
The short form letter of intent also takes less time to draft and get approved by both parties. It only covers the purchase price and a few key issues. However, the drawback is that this type of letter of intent leaves a lot to be negotiated later on, including many key issues.
The long form letter of intent is usually more desirable to the seller. The more terms spelled out in the LOI, the less likely it is that a deal will fall through due to a debate over certain details. An LOI offers them some sense of security before they agree not to try to shop their business to other buyers.
The type of letter of intent will depend largely on the parties and the type of deal they are going for.
The Parts of a Letter of Intent
The letter of intent, or LOI, usually has several parts. Most are listed here, provided it is a long form LOI. Short forms may have only some of the items listed below.
- Price/Consideration:How will the deal be structured? All or part stock, earnout, or promissory note?
- Adjustments to the purchase price:Will it be a cash-free/debt-free deal? Or will the deal be structured another way?
- Transaction structure: Will it be an asset purchase, a merger, or some other kind of purchase?
- Expected timeline: How long will it take for due diligence and to finalize the deal? What happens if someone misses a deadline or there is a delay?
- Escrow or No Escrow:Will there be escrow on the part of the seller? How long will it last?
- Exclusivity:How long will it last, how can it be terminated, and what are the consequences if it is terminated early?
- Access:What can the buyer access, from employees, to books, and records?
- Key representations and warranties of the seller
- Employees:How seller employee options and equity held by employees will be treated and whether these are in addition to the purchase price or subtracted from it.
- Activities:Things prohibited by the seller until final closing
- Third-party consents
- Confidentiality:The NDA and any other obligations of the parties concerning the transaction
- Conditions for closing
- Non-Compete:Whether the seller can engage in a similar business and solicit clients or whether they must sign a non-compete/
- Termination:How and when the acquisition agreement can be terminated
- Disputes (if any):How disputes will be handled and in what jurisdiction
There are other parts as well. You can see from this list how quickly an LOI can become complicated. This is why you need a business broker and an attorney to look things over whenever you are selling a business.
Binding vs. Non-binding Terms
Of course, both the buyer and the seller would love for certain terms to be binding even before final acquisition negotiations begin. However, that is often not how things work. The reason is that although both the buyer and the seller want the other party to be bound to certain terms, they don’t want to be bound to complete a transaction at this point.
There are some terms though that are binding for the protection of both parties.
- Confidentiality:Both buyer and seller can have reasons to keep many details of the deal secret, and this is often part of the non-disclosure agreement as well.
- Exclusivity:One of the primary reasons the buyer wants an LOI is so the business is not sold out from under them when they have spent time and money on the acquisition process. These terms are almost always binding.
- Conduct of the Business:The seller doesn’t want any surprises, so they like to stipulate that there are certain things the business cannot do when they are in the purchasing process.
- Dispute Resolution:How disputes will be resolved and where are often binding terms of the LOI.
This is where the LOI must be completely clear, so there is no misunderstanding between the buyer and the seller.
Price and Timeline
The price of the business and the timeline for exclusivity, due diligence, and other factors are also usually pretty important, especially to the seller. They don’t want the deal to be exclusive for too long, and then have it not go through. Even though it is common knowledge that a lot of businesses put up for sale never sell, they don’t want their business to be one of those.
It’s important that both of these things be reasonable, but also negotiable should something unforeseen happen. While typically not binding, the closer both the buyer and the seller can be to agreement on these points, the more likely the deal will go through in a timely way.
Besides time and price, employees are also one of the top considerations when selling a business. What will happen to key employees? Will compensation stay the same? What about benefits?
These should not only be part of the LOI, especially if it is a long form letter, but seriously considered by both parties. In some cases, if key personnel left in protest to the sale or the deal, the business could be drastically impacted.
Do you need a letter of intent? An LOI, while not legally mandatory, is a good idea for the protection of both parties. It increases the likelihood that the deal will close on acceptable terms in a timely manner. That is good for everyone, both the buyer and the seller and any other stakeholders.
Ready to sell a business and need help understanding an LOI and how to create one? A business broker can make sure the LOI covers everything it is supposed to. Contact us here at Rogerson Business Services to learn more.