The day has come when a letter of intent (LOI) has finally landed in your inbox. For some, this could be a culmination of weeks, if not months, of looking at qualified buyers. For others, it can be a short, fast process because someone from afar finds you interesting and makes an unsolicited offer.
Either way, how do you know what an LOI should cover?
First, you should download the accompaniment to this article, our Sample Letter of Intent (LOI)*. It shows you how everything in this article can be put into practice. Then, read on…
Ideally, you want your attorney to review it before it is signed, but sometimes it needs some major work or some very important deal points added before it is ready for signature. Instead of incurring legal fees for your attorney to write up additional items, it’s better to make sure the buyer sends you a very detailed and complete LOI in advance of sending it to counsel.
Remember, an LOI is a non-binding contract that precedes a binding contract, such as a share purchase agreement or asset purchase agreement (i.e., definitive agreements). An LOI is usually (but not always) non-binding. There are some provisions that are binding, such as non-disclosure, exclusivity, and governing law.
The purpose of the LOI is to crystallize the discussions up to that point and provide the seller with a clear articulation of what the buyer is prepared to offer. It is used as the outline for the buyer’s attorney to craft the definitive agreements. Therefore, it should be as complete as possible so that all parties involved are clear regarding the main points of the transaction.
Key Components That Should Be in Your LOI
There are standard things that almost all buyers include in a letter of intent, which I’ve listed below. If you receive an LOI that doesn’t contain these items, you should send it back and ask that additional items be included. However, you will want to check with your legal counsel to ensure that the specific items on your LOI make sense for your situation. We aren’t attorneys, and there is a great deal of capital and jobs on the line with a merger or acquisition. Therefore, it is extremely important that you review any M&A documentation with a legal professional.
Here are the key components that an M&A letter of intent commonly includes:
1. Transaction overview and structure (asset/stock): This will include purchase price, terms, and components.
- If asset deal: included and excluded assets
- Detailed explanation of earn-outs**, periods, and how they are calculated
- Percentage of equity interest and type of shares
- Signing bonuses or other bonuses to management
- Note amount, period, interest rate, and how often paid (both interest and principal)
2. Source of funds: Who will be providing the cash and equity: bank, PE firm, or self-funded? Remember to ask for proof of funds prior to signing the LOI.
3. Purchase price adjustments: This section usually covers what adjustments will be made against the purchase price (either up or down) and is usually associated with the amount of net working capital that is required at close. If the seller provides more, then the cash will be adjusted up, or visa versa. This is the section where a buyer may also indicate the amount of minimum cash that needs to be left behind.
4. Due diligence timeline and estimated close date: This section should indicate the period of due diligence, which is usually 90 days, and estimated closing date. All parties are required to work toward that due date, which may slip. This is especially important if you are trying to complete a transaction by year-end for tax reasons.
5. Confidentiality and non-compete periods: There should be a period specified for non-competition, as well as specific areas of the country, etc. This may include non-competition restrictions that prohibit the shareholders from soliciting employees, vendors and suppliers, and customers of the company for a specific period of time (usually 3 – 5 years).
6. Role and position, if staying: It is key to determine this in the beginning so there are no disappointments down the road. This should also include salary.
7. Tail Insurance requirements: Ideally, you want to know the type of insurance and the period of time for the coverage. It is common to request 3 years tail coverage for D&O, E&O, EPLI, and Cyber. Many times, tail insurance may be required for coverage you currently do not carry.
8. Conditions to the proposed transaction: This would include items such as approval of all shareholders, delivery of customary closing certificates, completion of due diligence, and approvals of governmental bodies, lenders, and other third parties, if necessary.
9. Indemnification escrows (or other escrows) and escrow period: Almost every deal with have an indemnification escrow or holdback. Typical percentages are 5% – 10%, depending on the size of the deal. Escrow periods are usually 18 months to allow for an audit post-sale, but can sometimes be negotiated down to 12 months. There may be a second escrow for net working capital.
10. Costs: This should indicate who bears the costs incurred in connection with the transaction, or that each party is responsible for their own transaction costs and expenses, including advisors, attorneys, and accounting fees.
11. Consents: If customer, vendor, or lessor consents are required, they should be outlined here.
12. Exclusivity period: This is typically 90 days. However, there may be additional language around extensions of time for additional weeks or days.
13. Public announcement: Many LOIs will indicate who will manage public announcements of the sale or if any will be made.
14. Termination: This will indicate how termination is done and what provisions remain binding post-termination.
15. Governing law: The LOI must indicate the state by which the letter will be governed. Usually this is Delaware, unless both the buyer and seller are in the same state.
Asking for Changes to Your LOI
Not every LOI warrants every component above due to the nature or structure of the deal. But if you feel a key section is missing in the LOI that you have been presented, then send it back and ask that it be added. It’s better to do it immediately rather than wait until the purchase agreements are written.
That said, there are times when both parties will agree that items can or should be changed from the original LOI based upon additional discovery and due diligence. There are also times when you don’t want to be extremely specific as it may not work in your favor this early in the process; due diligence may work more in your favor and allow you to negotiate more favorable terms. This is where your attorney should assist in that decision.
Keep in mind, at this stage of the process, you have more control as the seller to negotiate terms. Once due diligence starts, you lose that control. So, make the most of it now and get the best terms in your favor.
Conclusion
A well-crafted LOI is crucial for setting the stage for a successful merger or acquisition. By ensuring all key components are included, you protect your interests and pave the way for a smoother transaction. Remember, this is where the key points of the transaction are crystallized; it is often your best opportunity to negotiate the core terms and conditions of the sale. Don’t hesitate to request changes or additions before proceeding to the definitive agreements. With careful attention to detail and the guidance of a legal professional, you can confidently navigate this step of the M&A process and achieve the best possible results for your business.
* This Sample LOI is new and improved! So, if you’ve downloaded my Sample LOI in the past, don’t hesitate to download this completely updated one.
** Pro-Tip: When looking at earn-out payments, make sure you negotiate both an upside and downside. For example, if there is an earn-out in year two that requires you to meet a certain revenue amount or gross profit amount, make sure that if you are short by a small amount, you don’t lose the entire earn-out. By building in percentages, you ensure you get paid for what you do achieve (e.g., if you achieve 90% of the goal, you might earn 90% of the earn-out). The same would be true for the upside; if you achieve a much larger amount beyond the earn-out dollars, you should earn more money as well.
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