Letters of intent for buying/selling a business

Term Sheets

Corporate Update

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Letters of intent (“LOIs”), like term sheets, are essential documents in corporate transactions as they ‎outline the key parameters of a transaction so the parties can be on the same page before spending the ‎time and money to negotiate final legal agreements. Whereas term sheets tend to be used for raising ‎capital, LOIs are the preferred form for asset or share purchases, although both such documents have ‎essentially the same legal status as a guidance document with limited binding provisions.  ‎

The do’s of LOIs

1.‎ Focus on valuation and payment

The most important aspects of any business transaction is what is being transacted, how much is it ‎worth and how is it being paid for. Parties are typically clear on the ‘what’ is being sold (i.e. the whole ‎business or certain assets/operations) but LOIs must specify how this will be valued and purchased. Even when the parties have a clear price in mind upfront they should still specify if the purchase price ‎may be subject to any adjustments on the closing of the transaction (i.e. if there is a material change in ‎the business of the vendor, etc.). Where the exact purchase price is not specified, the parties must state ‎in the term sheet the method and timing of the valuation of whatever is being transacted. Finally, the ‎method of payment of the purchase price is also key; will all funds be disbursed on closing or over a ‎longer period with some upfront and/or held back? Will there be any purchase price adjustments over ‎time either for tax purposes or the future profitability of the business (referred to as an earn-out ‎provision)?‎

2.‎ Clearly state the key conditions to closing

Apart from what is being transacted and how it is being paid for, LOIs should also set out any conditions ‎required to be met prior to the execution of final agreements. These conditions commonly include ‎satisfactory due diligence by the purchaser or obtaining financing, but can often include certain ‎productions by the company/vendor, such as audited financial statements, financial projects, business ‎plans, etc. The purchaser may have their own undertakings prior to closing, such as agreeing not to ‎terminate certain employees and/or assume the vendor’s obligations under lease or customer/supplier ‎agreements. If either party wishes an opinion of legal counsel, often as to whether the other party may ‎enter the transaction with requisite authority, this should also be stated in the LOI.‎

3.‎ Keep things confidential

In most instances, a purchaser will conduct more detailed due diligence on the business vendor after the ‎LOI is finalized and, as such, the LOI should include a confidentiality provision to ensure sensitive ‎business information is not made public. Depending on the nature of the business being purchased, the ‎parties may wish to enter into a more fulsome confidentiality/non-disclosure agreement (discussed ‎elsewhere in this series) but, in any event, the LOI should still reference that any due diligence or ‎negotiations will be kept strictly confidential between the parties and their business advisors.‎

4.‎ Set a deadline

While much of the purpose of an LOI is to frame negotiations for a final, binding agreement, these ‎negotiations will often benefit from a deadline to close the transaction. This will help keep both the due ‎diligence and legal negotiations moving swiftly. Deadlines may also be important for tax planning ‎purposes if the transaction has to close in a certain fiscal year or quarter. When setting closing ‎deadlines it is good practice to allow the parties to mutually amend this date, especially if forces beyond ‎their control cause any undue delays.‎

The don’ts of LOIs

1.‎ Don’t get lost in the details

A LOI, like a term sheet, is a negotiating framework, not a detailed map of the transaction. As such, ‎parties should focus on the key business terms and not all the covenants, reps and warranties, dispute ‎resolution and other legal requirements of a final document. Parties should also not be afraid to move ‎the more detail-oriented or complex matters of the transaction, even including some of the business ‎terms, to the actual negotiations where there can be more time to get things right.  ‎

2.‎ Don’t lock up for longer than necessary

Purchasers will often seek the assurances of exclusivity when negotiating with a vendor and, as such, the ‎parties will often include a binding lock-up or standstill provision in an LOI that prevents the vendor from ‎negotiating with other parties. While often necessary, vendors must ensure that they do not lock-up for ‎longer than necessary to complete the transaction; we generally recommend between 60-90 days. Lock-‎up periods that go much longer than that will hurt potential market opportunities for the vendor if the ‎transaction doesn’t close with the purchaser signing the LOI. Like the closing deadline, the lock-up can ‎and should be extended by mutual agreement of the parties.‎

3.‎ Don’t forget to have both parties sign it!‎

LOIs are letters in form and addressed by one party to the other (though both parties will usually ‎negotiate its contents).  The party sending the LOI will sign it - as is the case for any letter - but don’t ‎forget to have a ‘sign-back’ from the recipient to ensure both parties sign the LOI.  This is especially true ‎when the LOI contains confidentiality or exclusivity provisions, which will not be enforceable without ‎mutual signatures.‎

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