Letter of Intent
The letter of intent is a useful tool that can facilitate a deal going
smoothly. What is a letter of intent? What are its primary uses? Should
you use one? What are the key issues that should be covered? This
addresses these topics and includes some pointers on drafting an
letter of intent summarizes the intentions of the parties and describes
the general price, terms and conditions of the transaction. The letter
of intent is generally drafted by the buyer and presented to the
seller. If both parties agree to the terms, each party signs the letter
and the transaction moves forward. The buyer then begins a detailed due
diligence process and directs its attorneys to draft the definitive
The letter of intent is the first step in
the closing process. This letter demonstrates commitment on the part of
the buyer. It shows that the buyer is serious and proceeding in good
faith. It is a rare situation when the buyer will send a letter of
intent without having serious intent to purchase the company. Firms are
simply too busy to bother with an LOI unless they are serious.
letter of intent is an excellent tool for moving a transaction forward
in a clear manner. In addition to demonstrating in the level of
seriousness on the part of the buyer, the LOI is an effective way to
solve issues early on so that they don’t need to be negotiated later.
It can prevent later misunderstandings. The letter clarifies the major
issues before the buyer begins drafting the definitive documents, which
is a time consuming and often an expensive task. Fewer deals fall apart
once a letter of intent has been issued.
If there are any key
issues or deal breaker issues, they should be negotiated before the
letter of intent is drafted. If there are any additional buyers that
the seller would like to discuss a sale with, these discussions should
be held prior to accepting a letter of intent.
Most of the
clauses in a letter of intent are not binding. However, there usually
are a couple paragraphs that are binding and can have serious teeth.
The letter should state specifically which paragraphs are binding and
which are not. Even though most paragraphs are not binding, buyers do
not issue LOIs casually.
The LOI encourages the parties to
negotiate in good faith and introduces an atmosphere of cooperation.
The letter should be drafted quickly, simply and with minimal back and
forth between lawyers.
For large acquisitions another reason to
use a letter of intent is that the LOI serves to start the clock for
complying with the Hart-Scott-Rodino Act. Parties must wait a specified
time period before consummating these transactions and the LOI starts
this time period.
The letter of intent usually covers five primary topics:
- Price and basic terms
- The no shop clause
- Employee matters
- Closing date
price is almost always specified in dollar terms. Sometimes it might be
specified in terms of a multiple of pretax profits or some other
metric. If the buyer is a public company and using shares of its stock
as the currency, the LOI should state whether the price is in terms of
a specific number of shares or whether it is a dollar amount. It may be
a good idea to set a minimum or maximum amount in case the share price
fluctuates significantly in the market.
The deal structure
should be specified. The structure is usually phrased as a
“purchase of assets” or “purchase of the outstanding shares” of the
company. If there are any unique or significant deal issues, it is a
good idea to include them in the LOI. Minor terms are not typically
specified in a letter of intent.
The buyer can adjust the price
later if it discovers issues in the due diligence process that warrant
changing the price or terms. However, changing the price stated in the
letter of intent without a good reason is not a good thing. A buyer who
does this should be regarded with suspicion.
of the most important binding terms is the “no-shop” clause, sometimes
called a “stand still” clause. The no-shop clause states that the
seller will not communicate with any other companies regarding the sale
of the business for a certain period of time. The language of the
no-shop clause usually is stated something like: “the buyer will not
solicit proposals or engage in discussions with other potential buyers.”
no-shop time period can vary widely. An acceptable time frame ranges
from one month to two months. Six weeks is a very good time frame. If
the buyer cannot perform its due diligence tasks within that period of
time, the seller should be free to talk with other parties. Any time
period longer than two months is overreaching on the buyer’s part.
There is no reason for a company to cease contact with other buyers for
more than 60 days.
During this period the buyer will undertake
its due diligence research to investigate the target company in depth.
The buyer will expend significant resources during the due diligence
process. The no-shop clause protects the buyer by giving it a window of
time to perform the necessary due diligence.
important and binding clause is the “no-hire” clause. This clause
protects the seller because it prevents the buyer from hiring or
attempting to hire any of the seller’s employees. Without this clause,
there could be a real problem. The buyer will have just spent time
meeting with and interviewing various employees of the seller and will
have a clear idea of which employees they would like to hire. Without
the no-hire clause, the buyer is free to contact and hire away any of
the employees. A well-drafted letter of intent should always have a
most transactions, a confidentiality agreement will have been signed
long before the parties reach the letter of intent stage. If, for some
reason, they have not signed a confidentiality agreement, the LOI
should specify that they do so or include confidentiality language in
the letter. If a confidentiality agreement was already in place, the
parties may wish to tighten up the terms of this agreement. The
paragraph on confidentiality is binding.
letter of intent should specify a closing date. This date is not cast
in concrete. It is usually an estimation of a likely time frame. The
date can be changed later by the parties to accommodate their schedules.
letter of intent may also contain numerous conditions to closing. These
conditions include items such as disclosures, approvals, access to
records, successful due diligence, legal issues and the signing of a
definitive agreement. The letter usually specifies that the seller will
conduct its business in its normal fashion and not change its
compensation to employees. These paragraphs are nonbinding and are
The letter of intent should also include
the date that the letter expires, which is usually about two to five
days from the date of the letter.
When an LOI is not
the basic price and basic terms have not been agreed upon, it is too
early to draft a letter of intent. It is important that the parties
reach agreement on the basic price and terms before employing an LOI.
The letter of intent simply summarizes this agreement in written form.
the seller is not ready to commit to that specific buyer, it should not
enter into a letter of intent with them. If other parties are still
interested in acquiring the company, it is best to explore these
avenues before signing a letter of intent.
If the buyer is
a public company, it may not wish to issue a letter of intent. The
reason why is that issuing a letter of intent is a “material event.”
Publicly traded companies are required by SEC regulations to disclose
any material event. Companies typically disclose an upcoming
acquisition through a press release to notify the public. If a publicly
traded company desires to keep the potential acquisition secret, it
will not utilize a letter of intent.
A letter of intent
sometimes can create problems. The drafter may inadvertently make all
or a portion of the letter binding. It might commit one or both of the
parties to something before they know all the facts. It may also tip
one’s hand in negotiations; the firm may want to hold some items back
to use as negotiating points later.
Another reason for not using
a letter of intent is that it may slow down the process. It is one more
thing to negotiate. Sometimes attorneys can get a little overzealous
and the LOI can take a significant amount of time to hammer out.
Tips for Good
just on the major points; omit the details. Make sure that agreement is
reached on the important issues. The letter should only be two to four
pages long; otherwise, too much detail is going into it.
- Mention specifically which terms are
meant to be binding and which are not.
- Draft the letter in the future tense.
- Specify that the transaction depends
upon the execution of a definitive agreement.
a number of minor items have been agreed upon, you might as well
include them in the LOI. As long as they do not open up discussions for
new arguments, the more that can be agreed upon early on, the better.
- The no shop clause should be six weeks
in length, not longer.