A good Letter of Intent (“LOI”) can make a big difference in getting your deal off to a good start. A good LOI can give both parties the confidence they need in order to keep moving forward with the deal. We have found that there is a really high correlation between having a good LOI and getting deals closed successfully. Below are few suggestions to help in getting a good LOI in place.
We’ve found that when both parties put in enough work and detail into the LOI, the quality of the LOI goes up quite a bit, and it is much better indicator of whether the parties have a deal, and whether it is likely to close. A positive indicator for us is that both parties have gotten their deal teams (especially the attorney and tax advisor) involved enough to indicate that key issues have likely been identified and resolved in the LOI.
Sometimes, we will see one or both parties view the LOI differently, planning to significantly rework key portions of it later as more information is obtained. That isn’t necessarily a bad approach or the “wrong” approach, but it is important for both parties to understand how reliable the LOI is, and what to expect from the rest of the process.
- Put Enough Work and Detail Into the LOI: We’ve found that when both parties put in enough work and detail into the LOI, the quality of the LOI goes up quite a bit, and it is much better indicator of whether the parties have a deal, and whether it is likely to close. A positive indicator for us is that both parties have gotten their deal teams (especially the attorney and tax advisor) involved enough to indicate that key issues have likely been identified and resolved in the LOI.
Sometimes, we will see one or both parties view the LOI differently, planning to significantly rework key portions of it later as more information is obtained. That isn’t necessarily a bad approach or the “wrong” approach, but it is important for both parties to understand how reliable the LOI is, and what to expect from the rest of the process.
- Key Terms to Consider Including:
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- Clear Non-Binding Language: There should be clear language identifying which provisions of the LOI are binding and which provisions are not.
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- Purchase Price and Payment: The purchase price should be included, and should specify how it will be paid, especially if it will include any non-cash compensation, or payments after closing. The items below can have significant economic impacts on the parties, and addressing them in the LOI can be really useful in helping the parties be able to rely on the purchase price. Without addressing these terms, it’s possible the parties could be tens to hundreds of thousands of dollars apart on what they expect to receive out of the deal, which could become a deal breaker.
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- Tax Structure: It is helpful to be clear on whether the deal will be an asset purchase or a stock purchase, which can have significant tax consequences for both parties. Any key tax elections, such as a 338(h)(10) election (which allows a stock sale to be treated as an asset sale for tax purposes), should be addressed as well.
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- Net Working Capital and Debt: Net working capital is usually tens of thousands and even hundreds of thousands of dollars or more. If it will not be included, it will impact the buyer’s financing plans. A specific number doesn’t have to be included in the LOI (and often the parties don’t know enough to set a good number yet at that point), but the concept of whether or not historical working capital will be included should be addressed. The same concept applies to whether the seller must pay off some or all debt at closing, and whether any debt will be assumed by the buyer, or retained by the purchased business.
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- Include all “Deal Makers” and “Deal Breakers”: The best time to get the deal you want is usually when you have the strongest bargaining position. For many parties that will be when they have the greatest freedom to walk away, which is often before there’s even an LOI in place. We’ve found it is most helpful when the LOI includes both parties’ “deal makers” and “deal breakers”. “Deal makers” is a term we use to refer to all of the terms that must be a part of the deal for it to make sense for that party. “Deal breakers” is a term we use to refer to things that would break the deal for a party if it were included.
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- Key Value Transition Activities: If there are any key activities that are necessary for transitioning the value of the business to the buyer, such as transition services from the seller or owners or key personnel of the selling entity, it can be helpful to clearly address those in the LOI, especially if the seller or owners are expecting to retire.
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- Restrictive Covenants: Non-competes and non-solicitation obligations should be addressed.
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- Exclusivity or Non-Exclusivity: Address whether the rights of the parties under the LOI are exclusive or not, and how long any exclusivity lasts.
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- Confidentiality: The LOI should address confidentiality, and whether there is a separate NDA in place.
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- Termination: The LOI should very clearly state how the parties get out of the LOI and end the negotiations.
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- “No Shop”/”No Talk”: Sometimes, it will make sense to include a term that prevents the seller from continuing to look for other buyers (a “no shop”) and/or that prevents the seller from talking to other buyers if approached (a “no talk”).
These resources are provided for informational purposes only, and are not legal advice. No attorney-client relationship is formed through this page. Please contact us if you’d like to inquire about our services.