If you are buying or selling a business, one of the preliminary documents often discussed is a Letter of Intent (LOI, for short). Do you really need an LOI, though, or can you just fast-forward to the closing?
Experience speaks volumes, and the answer is that yes, you definitely need a Letter of Intent. A business purchase and sale is a process that involves numerous factors – assets, financials, employees, contracts, liabilities, and possibly real estate – so if you move too fast, you might not have everything figured out by the time you want to close.
A Letter of Intent gives the parties the opportunity to discuss, and, hopefully, to come to an agreement on, many of the important aspects of the deal before the attorneys start drafting the Asset Purchase Agreement. Having an agreement in principle on the broad outlines of the deal will make it easier than leaving some of those details to the last minute.
Here are a few examples of items that should be considered in an LOI. These are by no means exclusive:
Structure: will the purchase be an Asset Purchase Agreement, or possibly a Stock Purchase Agreement?
Deadline for due diligence (the buyer’s investigation of the financial and legal condition of the company).
Deadline for closing the transaction.
Price adjustments – What mechanisms will allow the preliminary agreed-upon price to change, (such as changes in growth or loss in revenue)?
Exclusivity: the buyer should have the exclusive right to purchase the business during a certain period of time, and the transaction should be taken off the market.
The obligations of the parties are to keep all discussions and proprietary business information confidential.
Other conditions to closing (e.g., financing).
Grounds for being able to terminate the Letter of Intent.
How the parties will resolve any disputes, such as by arbitration, court, or some other mechanism.
These are just samples of terms that need to be considered in an LOI. Each deal is different and will require that the terms and conditions be adjusted to accommodate that transaction.
Price adjustments, mentioned above, are especially important. If the buyer and seller agree on a preliminary price, one of them may try to increase or decrease it. Why might this happen? Say, for example, that the parties agree on a price of $10 million. They then commence due diligence to investigate the financial condition of the business. The buyer might find out that the seller’s contract with a major customer is expiring soon and there is no guarantee that it will be renewed. Or, an asset belonging to the business may turn out to have been overvalued. There are numerous reasons this might happen. In such cases, the buyer may (quite reasonably) demand a lower price.
The exclusivity period is also important. The last thing an enthusiastic buyer wants is for the seller to shop the offer around to other potential buyers to see if someone will pay more. It is essential that there be contractual language preventing the seller from doing this.
Another term might be the earnest money deposit. Many, though not all, transactions require the buyer to put down a percentage of the purchase price in escrow as a show of good faith. If the transaction falls apart, who will get this money? It’s important to say in the Letter of Intent who, how, and when that money will be kept or forfeited.
All the terms of the Letter of Intent are important, which is why it’s advantageous to have legal counsel on your side representing you from the beginning of the process. Clients sometimes come to us with a Letter of Intent that has already been negotiated and signed. If that happens, it may very well be too late to include some of the protections that you need to make sure the transaction goes seamlessly, or to gain the most financial benefit from the transaction.
In conclusion, the Letter of Intent is arguably the most important document in the acquisition of a business because it lays out both parties’ expectations for the remainder of the transaction. Ensuring that your Letter of Intent covers any potential issues helps to ensure that the remainder of the transaction goes according to everyone’s expectations.
Dye Culik PC is a Charlotte, North Carolina business law firm representing buyers and sellers in business transactions throughout the state. Before you buy or sell a business, contact us to see how we can help add value to your transaction.