Anatomy Of A Letter Of Intent

In the world of business mergers and acquisitions, you often find initial announcements that refer to a letter of intent. What is it? It’s easiest to think of a letter of intent as a documented handshake between a potential buyer and a potential seller that lists the principal points of an agreement before it is finalized.

Why is a letter of intent necessary? One reason is that a letter of intent helps ensure that the business transaction will proceed as planned, reducing the risk that prolonged and expensive negotiations might not result in a closing. Another reason is that you might not have a choice. With transactions that require financing, the buyer’s lender might require a signed letter of intent before issuing a commitment to finance the acquisition.

Benefits

A letter of intent provides other often overlooked benefits:

• Even though most provisions are non-binding, it signals a commitment between the parties and may serve as an official announcement.

• It also lays out the timeline and milestones required to complete the transaction. For example, it will specify the expected timing of due diligence, definitive agreements and the closing date. This keeps the process moving and serves as a reference if one or more parties fall behind schedule.

• A letter of intent might even enable accelerated compliance with regulatory requirements such as those under the Hart-Scott-Rodino Antitrust Improvements Act.

To be most effective, it’s critical that a letter of intent clearly delineates the binding provisions from the nonbinding ones. Here’s the difference between them. The binding provisions regulate the negotiation process. The nonbinding provisions outline the transaction and its structure. Note that even though they’re nonbinding, there is a "moral commitment" by both sides to abide by the nonbinding provisions.

Binding Provisions

Here are several binding provisions you can find in a letter of intent:

Here are several binding provisions you can find in a letter of intent:

• Binding provisions might include buyer access to the target company’s facilities, books and records.

• Binding provisions might require cooperation from the company to be acquired during the due diligence process.

• They might contain a "no-shop," "stand-still" or "exclusive-dealing" provision that prohibits the acquisition candidate from directly or indirectly soliciting or entertaining offers from, or negotiating with, third parties in a transaction similar to the one the letter of intent outlines.

• The seller must operate the company in the ordinary course of business.

• A mutual, comprehensive confidentiality and non-disclosure provision protecting both parties, and encouraging forthright or good faith dealings is also customary.

• Binding provisions indicate that each party typically bears its own costs and expenses and helps the other prepare and file for any necessary consents or approvals from lenders, landlords or third parties.

• It’s advisable to include a statement that the binding provisions constitute the entire agreement between the parties, superseding all prior oral or written agreements, and that the letter of intent may be modified only in writing, signed by both parties.

The binding provisions may also specify jurisdiction and venue for any disputes involving the letter of intent. It might be wise to include a provision relating to the letter of intent’s termination, perhaps including a break-up fee. But note that the break-up fee normally isn’t the only remedy in the event of a breach by the seller.

Nonbinding Provisions

The nonbinding provisions may be broadly scoped. They can include a description of the transaction type, a good-faith estimate of the closing date and a summary of the target executives’ employment agreements. They may also incorporate an adjustment to the purchase price based on changes in the consolidated stockholder’s equity following a specified date. They will address the preparation and approval of definitive documentation that will contain customary and comprehensive representations, warranties, indemnities, terms and conditions. Also, they can set forth escrow provisions for holding back a portion of the purchase price for specified contingencies.

Warning: Be Clear And Concise

The person who drafts a letter of intent must ensure that the nonbinding provisions cannot morph into binding provisions. The most powerful weapon against this danger is clear and concise draftsmanship. However, the courts have given significant weight to communications and other actions between the parties. For example, a statement such as "we have a deal," followed by handshakes all around, might persuade a court that the parties intended to be bound.

A Simpler Alternative

Do you have to use a letter of intent? In a word, no. Some buyers and sellers prefer to use a term sheet instead. A term sheet is a bullet-point document outlining the material terms and conditions of a financial or purchase agreement. Term sheets are very similar to letters of intent in that they are both preliminary, mostly nonbinding documents meant to record two or more parties’ intentions to enter into a definitive agreement based on certain (incomplete or preliminary) terms.

The difference between the two is slight and mostly a matter of style. A letter of intent is typically written in letter form and focuses on the party’s intentions. A term sheet skips most of the formalities and lists deal terms in bullet-point or similar format. There is an implication that a letter of intent only refers to the final form, while a term sheet may be a proposal, not an agreed-to document.

Term sheets offer a few advantages: They tend to be simpler than letters of intent, enabling both parties to focus on the most important terms or big picture; and they can be drafted more quickly, allowing the parties to get to the bottom line with less expense and exposure.

Regardless of the form used, once a letter of intent or term sheet has been executed, it guides legal counsel in the preparation of definitive agreements. It also guides the signatories and their financial and legal advisors as they finalize the terms of their agreement.

A Smoother Transaction

Nothing guarantees that a deal will close successfully or at all. But a carefully crafted letter of intent or term sheet certainly paves the way to a smoother transaction. In essence, they’re written agreements with the business that is to be acquired that are made before the purchaser incurs full-blown legal and due diligence costs.

 

 

 

Matthew J. Miller is a managing director at BlueWater Partners, a middle market investment-banking firm. As strategic advisors to business owners and management, BlueWater Partners works with companies to create, manage and realize business value, frequently before or through a sale or acquisition. He can be contacted at matt@bluewaterpartners.com.

matt@bluewaterpartners.com.