One of the most individually significant documents in an M&A transaction is the letter of intent (LOI). The LOI may be called a “term sheet” or a “memorandum of understanding,” and it summarizes the primary terms and structure of an M&A transaction. Depending upon whether you are the buyer or the seller, the LOI can impact you differently so it is critical to understand and thoroughly evaluate the key provisions of the agreement.
The LOI typically includes many of the following provisions:
- Purchase price and terms
- Escrow or holdback obligations
- Assets to be acquired and liabilities to be assumed
- Form of consideration or payment
- Legal structure of transaction (asset or stock sale)
- Seller’s post-transaction role
- Financing or other contingencies to close
- Due diligence process
- Deadlines or milestones
Many of the provisions of an LOI are non-binding, but those affecting termination, exclusivity, confidentiality, public announcements, etc., may be legally enforceable. From a buyer’s perspective, the exclusivity clause is key as it requires the seller to take the business off the market and cease negotiations with other buyers. This severely weakens the seller’s negotiating position.
The greater the level of detail in the LOI, the less likely the opportunity for surprises or significant changes when the definitive purchase agreement is drafted. Therefore, sellers often prefer a more comprehensive LOI to potentially identify any issues that could derail the transaction. Sellers should require that terms be defined to avoid misunderstandings later. Buyers, on the other hand, prefer a broader LOI that will provide an opportunity to negotiate a more favorable purchase price should any issues be uncovered during the due diligence process.
It is not unusual that several iterations of the LOI are prepared before the buyer and seller agree on the language and sign the document. While the initial focus may be on the purchase price, provisions impacting the structure of the transaction, due diligence procedures, and conditions required to close can have a dramatic impact on the deal and should be given thoughtful consideration. Since the buyer will often be drafting the final purchase agreement, you can expect that any terms of the proposed transaction that are not clearly defined in the LOI will be drafted in the buyer’s favor in the purchase agreement. If you are a seller, once you sign the LOI, your negotiating leverage has diminished.
Whether you are a buyer or a seller, working with experienced M&A advisors can help you navigate the LOI process and allow you to move on to the due diligence phase. The LOI is a critical step in the M&A process and one whose importance should not be underestimated.
Mark G. Metzler is a Director with Kreischer Miller and a specialist for the Center for Private Company Excellence. Contact him at Email.
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