The Letter of Intent (LOI) is a pre-contractual written instrument prepared by the buyer for the seller, which is usually the preliminary understanding of both parties. The Letter of Intent can also be called Agreement in Principle or Memorandum of Understanding. They all have the same general meaning and lay out the following: What is being purchased and what is not, how much will be paid, and the general terms. It is also meant to be non-binding (more on this a bit later) on either the sell side or buy side.
In any event, most transactions are started with an LOI. The LOI precedes the Acquisition Agreement, better known as the Purchase and Sale Agreement. It is a non-binding agreement subject to the buyer obtaining satisfactory due diligence by both parties.
This is how the LOI has been defined by Stanley Foster Reed, author of The Art of M&A:
“A Letter of intent is a pre-contractual written instrument which defines the respective preliminary understandings of the parties about to engage in contractual negotiations. In most cases, such a letter is not intended to have a binding effect except for certain limited provisions. The Letter of Intent crystallizes in writing what has, up to that point, been oral negotiations between the parties about the basic terms of the transaction. While the Letter of Intent is usually non-binding, it does create a moral commitment and allows the buyer to proceed with the extensive due diligence process with a feeling of confidence. Conversely the seller is required to withdraw the company from the marketplace and not discuss the potential sale with anyone else.”
The elements of the Letter of Intent are as follows:
- The price of the company
- The form of purchase: Is it a stock or asset sale? What is being purchased and what is not?
- The structure of the sale: Specifications about cash, notes, stock, non-competes or consulting agreements, contingencies, etc.
- Management contracts: Specifics about for whom, duration, and incentives
- Closing costs and the responsibilities of the buyer and seller, such as environmental due diligence and title searches
- Representations and Warranties: Boilerplate legal statements
- Brokerage fees: Who pays and how much?
- Timing for completion: Drop-dead date for due diligence and financing period; How long before money is exchanged and final closing takes place?
- Insurance: Proof of insurability; What happens with policies?
- Disposition of earnings before closing and viability of non-ordinary expenditures before closing (conduct of business)
- Access to books and records, key customers, and key employees prior to closing
- Disclosure of any outstanding non-compete agreements or obligations with third parties
- Stipulation of confidentiality of buyer (a breach could cause the seller to sue the buyer): The buyer promises not to disclose information about the seller to outsiders and to not disclose that negotiations are underway.
- Seller will take the company off the market for a designated period of time of forty-five to sixty days (a breach could cause the buyer to sue the seller).
The LOI is at the heart of the transaction and reveals key issues early on in the process. The signing of the Letter of Intent begins the buyer’s due diligence process and his or her ability to secure the necessary financing. Although the LOI is just the beginning of a lot of necessary paperwork, both sides will assume that the LOI represents the basics of the deal and that they have reached an agreement in principle.
For more such information, get in touch with IBBA Canada.