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Letters of Intent, Part II: Common Terms

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In my previous post on Letters of Intent, I posed the question:  Is using a letter of intent for a sale or acquisition of a business, or other M&A transaction, worth it?  To answer that question, I offered benefits to both a seller or target company on the one hand, and a buyer or acquiring company on the other.   I hope I convinced you that, in most if not all cases, there are significant enough benefits for both sides in a potential acquisition or merger transaction to merit the use of a LOI (also sometimes called a memorandum of understanding, a term sheet, a summary of principal terms, or heads of agreement).

As promised in my previous post, in this post I will tackle the rationale and reasons behind some of the more common LOI terms.  In a  future post I will discuss why some atypical or uncommon terms may be appropriate for a particular potential M&A deal. The sample LOI that I'll refer to in this post is available here.
First, the structure of the proposed transaction should be identified early (e.g., a stock sale or exchange, an asset sale or exchange, or a statutory merger).  In the sample LOI, the introductory paragraph identifies the asset sale structure.  In addition, in the Summary of Terms attached to the LOI as Exhibit A, the structure is reiterated and the assets to be purchased are described in more detail (and depending on the extent of excluded assets, even more detail may be needed).  Second, the consideration to be paid by the buyer for the assets also should be addressed upfront, and is described in the third item in Exhibit A.

The structure of the proposed transaction and the proposed form of deal consideration (e.g., cash, stock or other form of equity of the buyer, or debt, such as buyer’s promissory note, or combination of those forms of payment) will drive many important potential considerations in evaluating the desirability of the deal from the seller’s perspective.  Those considerations include income tax consequences, any necessary shareholder or other owner approvals, possible consents or approvals of third parties for a transfer of assets or a change in control that may be required by various agreements the seller has entered into with those third parties (including real estate and equipment leases and vendor or customer contracts), whether employees will need to be terminated prior to the closing (and potential minimum advance notice of such terminations under federal and state plant closure or similar laws), and post-closing actions of seller such as the liquidation or other disposal of any assets not sold and the dissolution of the seller in the case of an asset sale.

The purchase price section of Exhibit A identifies who is responsible for paying any sales or transfer taxes.  In an acquisition structured as an asset sale, this can be an important issue if there are significant items of personal property besides inventory that will be transferred and California’s occasional sale rule will not apply to exempt the transfer of those items from sales tax.  The sales tax rates in California currently range from between 8.25% and 10.25%, with many counties at the 9.75% rate.  Depending on the fair value of the those items when transferred from the seller to the buyer, the total amount of sales tax payable can either reduce the net proceeds to the seller or increase the effective purchase price paid by the buyer in a significant manner.
My next post will review the conditions to closing that are listed under Exhibit A of the sample LOI.  Future editions will review the remaining terms of the sample LOI and its Exhibit A, as well as more uncommon terms.

Terrence P. Conner, Business Group

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