After a seller and buyer reach an agreement, the buyer should prepare an acquisition letter of intent (LOI). This is a formal letter that reflects everything the two parties have agreed on. It outlines the overall structure of the deal, management arrangements, the period of due diligence, and other details.
The letter of intent is similar to other types of contracts. The only difference is that, as long as it’s outlined at the beginning of the letter, the terms described in it are not legally binding. The only exceptions are clauses of exclusivity, confidentiality, governing law, and expenses. The seller can read the letter of intent and request edits or add new points to those proposed by the buyer.
Usually, letters of intent are drafted by legal teams, but in this case, an LOI can be stuffed with legalese and therefore difficult to comprehend. A good LOI should be easy to understand, especially given the fact that it’s not fully legally binding. Usually, letters of intent include an introduction, the structure of the deal, transaction closing conditions, and indemnification obligations. However, an LOI can also include other sections, depending on the type of the deal.
Long-Form and Short-Form Letters of Intent
Short-form letters of intent may only address a few key terms and the price. For example, such LOI may outline any escrow holdback to protect the seller’s indemnification, the length of escrow, and the no shop right or exclusivity for the buyer. Short-term letters of intent are much quicker to negotiate. However, if you choose this type of LOI, you will need to discuss many important issues later.
Long-form letters of intent are more comprehensive and include many terms of the potential deal. Besides, they are more legally constructed. A long-form LOI enables you to quickly resolve issues that can be deal-breakers. Resolving the key issues as early as possible can make it much easier for you to reach a definitive acquisition agreement, saving time and money.
At the same time, long-form LOIs have certain disadvantages. Sometimes, time is very important, and if you’re close to getting a deal done, a long-form LOI can make you lose momentum. Besides, sometimes it may lead to a breakdown of negotiations that you could have avoided if the discussion of some important issues had been postponed.
Writing a Letter of Intent
This is the first section of an LOI that includes the general terms. The introduction may also outline the context of the purchase or explain the similarities between the business that’s being acquired and the buyer’s existing business. We also recommend that you clearly indicate that the LOI isn’t legally binding. Although LOIs are generally not legally binding, you should keep in mind that there is no clear agreement among attorneys regarding this issue so we recommend that you clarify it at the beginning.
The deal structure is the most important part of the LOI. You may need a legal expert’s help when writing this section if the structure of the deal is somewhat more complicated than a complete takeover. This section should also clearly indicate what type of payment is required and when it should be made.
If the owner of the business will remain involved in it, this section should also outline the terms of the owner’s employment. Just like any other employment contract, this section must include incentives for managers and explain what contribution they can make.
It’s very important to choose an appropriate tone for the previous section because it is followed by the indemnification obligations. This section is the second most important part of the LOI after the deal structure, and it should explain possible solutions if the business suffers a significant decline because of the deal.
The scope of indemnities may vary. If you’re not familiar with this concept, you should know that the indemnities are described in terms of "baskets" and "caps". Baskets help the seller by indicating how much losses the buyer can take before receiving compensation. Caps indicate the amount of compensation the buyer can receive from the seller.
Transaction closing conditions
Usually, the closing conditions include financial and regulatory conditions that should be met to close a transaction. For instance, a takeover might need some regulatory approval, which is especially common when foreign buyers purchase U.S. companies. The buyer may also be unable to complete the transaction until they get the necessary financing from a third party.
Once you’ve written an acquisition letter of intent, it can serve as the roadmap for your deal. Even though such documents are not legally binding, if you change anything in an LOI, such actions can have serious consequences for the deal. At the same time, you must be ready to consider some changes offered by the seller.
A well-written letter of intent can help you close an acquisition successfully, on the best terms. We hope that our quick guide will help you figure out the main aspects of an LOI so that you won’t forget any important details.
Jean Schneider is an entrepreneur, lawyer and academic writer at legitwritingservices.com. Jean writes articles related to trade law and helps students make informed decisions if they’re looking for some academic help. Other than that, she spends a lot of time on writing her first book about entrepreneurship.