What is a Letter of Intent?
A letter of intent is a document, often in letter format, that a buyer uses to express interest in buying property. Because I deal mainly with people buying and selling businesses, this legal guide focuses on letters of intent dealing with business mergers and acquisitions. Generally, the buyer proposes a certain deal in an initial letter of intent. Rarely is the letter of intent signed as is. Rather, the seller often negotiates various terms in the letter of intent which are important to the seller. Only once the parties are in agreement is the letter of intent signed.
What purpose does a letter of intent serve?
The letter of intent allows the parties to negotiate the preliminary aspects of a deal without wasting their time if it looks like a deal will not be able to be completed. Why spend a lot of time in due diligence and drafting final purchase documents if the deal has little likelihood of being completed? The letter of intent will typically set forth the basic structure of the deal (stock or asset sale), the purchase price and how it will be paid (all at closing, over time, earnout structure, etc.) as well as other items that are important to the buyer and seller. The LOI also allows the parties to begin the due diligence process and negotiation of final purchase agreements without the seller selling the business to another buyer. The LOI should specifically provide that the business is not marketed by the seller for a certain period of time. This helps prevent the buyer from incurring expenses only to find the business was sold to someone else
Should I use a long or short form letter of intent?
The answer to this question varies from deal to deal. There are both a psychology to the deal as well as economic practicalities to consider. Generally speaking, after a letter of intent is signed, the seller experiences a psychological shift in attitude. The seller begins to operate the business with "one foot out the door" and may be more likely to make concessions in negotiations. Therefore buyers often prefer a short form LOI in order to move the deal along. Conversely, good sellers' attorneys recognize this psychological shift occurs and will encourage their clients to make sure that all major points are covered in the LOI. Economically speaking, the buyer may also prefer a longer LOI in order to help limit expenses down the road. The due diligence process and drafting final documents is not inexpensive and some buyers will prefer longer LOIs in order to make sure their key points are addressed.
Should the letter of intent be binding or non-binding?
The answer is "both." Generally deal terms change as the parties perform due diligence and begin more serious negotiations. Therefore the parts of the letter of intent covering deal terms should be non-binding. The clause making the LOI non-binding should be very carefully drafted so that a party can't sue the other party to "complete the deal" if no final agreement is reached. Preventing litigation in this context is key to both parties. However, the sections of the LOI dealing with taking the business off the market and giving the buyer the exclusive right to investigate the purchase of the business should be binding. The amount of time for the business to be taken off the market will often be hotly negotiated with the buyer preferring a longer time to look at the business and sellers preferring a shorter time to keep their business off the market.
Though we all use forms in starting a letter of intent, forms should be used with caution. It is important to make sure your client's specific situation is taken into account and any "hot button" topics are addressed in the letter of intent in order to avoid later surprises.