Insights

The Role of the Letter of Intent

By: Richard H. Mains, Member

One of the early-stage, primary questions that arises in connection with the purchase or sale of a business, or other important transaction is whether or not the parties should enter a letter of intent (“LOI”).  While not always appropriate or justified, an LOI can serve an important role in a transaction.

An LOI typically sets forth the intent of the parties in the proposed transaction as to the key terms and conditions.  Some LOIs may be brief, outlining only the purchase price, transaction form (e.g., stock or asset sale), anticipated timing and other minimal details.  Other LOIs may be lengthy and include almost all material terms, including details about anticipated due diligence and its timing, specific conditions to closing, a detailed “no shop” clause, which party will propose the initial draft purchase and sale agreement and jurisdiction and venue for disputes under the LOI.

An LOI is not a necessity in a transaction.  For instance, in some transactions a simple term sheet may satisfy the parties that their expectations are aligned and justify proceeding with due diligence and negotiating documentation.  In other transactions, the parties may desire to skip even a term sheet and proceed to drafting the final, definitive agreement and negotiating the material terms within that document.

If the parties choose to enter an LOI, considerations include the following:

• Clarity. The primary purpose of the LOI is to set forth the parties’ mutual understanding of the basic transaction terms before committing significant time and resources to detailed negotiations and diligence. At a minimum, the purchase price, deal structure and any major contingencies should be addressed.  For the terms that are addressed in the LOI, the parties should be confident those terms align with how they would like the transaction to proceed and are set forth clearly.
• Negotiation.  It is at the LOI drafting stage that the most significant deal points should be negotiated.  While market circumstances change and the results of due diligence may give good reason for tweaking the deal terms, it can be difficult in subsequent negotiations to obtain mutual agreement on changing terms that are outlined in a fully signed LOI.
• Level of Detail. There is no set convention on how detailed an LOI should be.  Each party must use its own judgment in deciding if, based on the other details in an LOI and the parties involved, it needs to raise any specific details important to it for inclusion in the LOI or if the detail should wait for negotiation in the definitive agreement.
• Binding Provisions. Typically, LOIs expressly state they are non-binding except for specifically identified sections.  The binding sections tend to be provisions governing exclusivity of negotiations for a set period of time, confidentiality, venue and jurisdiction for disputes under the LOI and governing law for the LOI.
• Exclusivity. One of the most negotiated sections of an LOI is often the “no shop” provision.  It will provide that the seller will refrain from entertaining other offers for a set period of time, frequently from 30 to 90 days, but sometimes shorter or longer depending on the circumstances.  The justification from the buyer’s perspective is, if the buyer is going to expend the time and resources to conduct due diligence and negotiate documents, the seller should deal exclusively with the buyer for an adequate period to permit buyer’s due diligence review and for the parties to enter a binding, definitive agreement.  The seller’s concern with a lengthy exclusivity period is removing the business from the market for too extended a period risks the opportunity becoming stale, or other potential purchasers losing interest, in the event the buyer does not proceed to closing.
• Setting the Tone.  The tone of the proposed LOI and its negotiation often sets the tone for the parties heading into due diligence and contract negotiations.  A party’s approach in the LOI negotiations can be a way of conveying a cooperative attitude toward the transaction or set a tone of difficulty that may aid or burden the early phases of contract negotiation.

While there is no “one-size-fits-all” for LOIs, they can be important tools in the early stages of a prospective transaction. Interested parties have the opportunity in the LOI to advance their objectives for the overall transaction and convey, when appropriate, their expectations of the other party.