Is a Letter of Intent Really Necessary?

By March 23, 2010 Blog, Business Law

Is a letter of intent  for a sale or acquisition of a business, or other M&A transaction, worth the paper it’s written on?  Why spend time and money on negotiating and drafting a letter of intent (aka memorandum of understanding, term sheet, summary of principal terms, or heads of agreement – all referred to as a “LOI”) that is, for the most part, non-binding?   These are common, but important, questions, and as with many legal questions, the most accurate answer may be – it depends.   When considering an LOI, however, the answer is clear: much can be gained by going through the process of negotiating and signing a LOI.
From a seller’s perspective, it’s important to learn whether the seller and prospective buyer are on the same page regarding the principal deal terms such as type or structure of the potential deal, price, payment terms (including any financing contingencies), possible non-competes for key employees/shareholders, indemnification rights and obligations, holdbacks, timing for completing due diligence, outside date for signing the definitive agreement, and the closing date. The buyer wants to find out many of the same things, but also wants to tie up the seller by imposing a lock-up or exclusivity period to prevent the seller from negotiating with others.
Although the binding parts of a LOI usually favor the prospective buyer, a seller may also reap benefits from the signing of a LOI by placing a stake in the ground and obtaining what may be viewed as an ethical commitment from the prospective buyer regarding principal deal terms.  In addition, the seller can try to use the leverage of the buyer’s desire to lock-up the seller to discuss additional deal terms and ideally resolve them to the seller’s benefit early on by including them in the LOI.  The earlier in the negotiation process the seller can resolve significant deal issues, the more comfortable the seller will be about providing the buyer with extensive and detailed due diligence information, including voluminous financial information and sensitive and valuable intellectual property or other proprietary or confidential information.  Even though a non-disclosure or confidentiality agreement will protect the seller against the unauthorized use or disclosure of seller’s important information, before that disclosure occurs, with its increased level of business risk to seller, the seller will want to be in a strong position.  An LOI can certainly help achieve that goal for the seller.
For an example of a LOI that contains typical terms in the context of an asset sale, you can click here.  In future blogs, I will explain the rationale behind certain of the terms in a LOI and include some atypical terms and why they may be appropriate for a particular potential M&A deal.
Terrence P. Conner, Business Group