A letter of intent is the preliminary agreement entered into between a buyer and a seller. This document summarizes the terms and conditions that a buyer is proposing. When a LOI is executed, then the Buyer and Seller have in principle agreed to the terms and conditions of the transaction. We will generally be taking the Buyers point of view as in previous posts.

• Structure - it is important to know how the deal is structured from tax and legal perspectives. For example, is it an asset purchase or stock purchase? Will there be a 338(h)(10) election? Structure is very important for the Seller as it determines the amount of taxes it pays. Likewise, a Buyer may be able to pay more for a company depending on how an acquisition is structured.
• Price and Terms of Consideration - outline of the total consideration being paid to the Seller, the type of consideration being paid and the timing of the consideration being paid.
  • For example, a Seller may be receiving $10 million up front plus another $5 million that is contingent based on earnings performance over a three-year period. This should all be outlined so that the Seller understands the nature of consideration that it is receiving.
• Included Assets and Liabilities - LOI should always state the assets included and excluded in the transaction so there is no confusion. Typically, a Buyer doesn’t want to take any liabilities other than standard accounts payable, if that.
• Working Capital Adjustment – this is always a sticking point for Buyers and Sellers. Sellers always believe their businesses are able to run with lower working capital and therefore want to include a smaller amount for the Buyer. However, Buyers obviously have a different perspective. A Buyer will argue that the historical level of working capital is an accurate representation of steady state needs and will want as the Buyer calls it – an appropriate level of working capital. For a general guideline, Buyers will seek 60 days of working capital.
• Access to Information / Due Diligence & Closing – Sellers want to know that Buyers will try to close the transaction in an efficient and quick manner. They don’t want something dragging out or worse yet, the Buyer backing out of transaction. Meanwhile, Buyers want to be able to investigate and conduct various types of due diligence to confirm that they are not overpaying for something. It’s good for both sides to have a some timeframe for due diligence and notification of any dealbreaker issues. Generally, 45-60 days is a good timeframe to allow for the Buyer to investigate and close the deal.
• Conditions to close – Buyers will caveat its ability to close the transaction by listing some conditions to close. The following are typical conditions and language that are in most, if not all, LOIs.
  • Negotiation of Satisfactory Purchase Agreements – remember, a LOI is preliminary and there is still a lot of work and detail that goes into documenting the transaction in granular detail. If a Buyer and Seller cannot agree and some of the finer points, the transaction may not occur. A Buyer does not want to incur significant legal fees so this is why a Buyer generally hold of on complete legal documentation (the Purchase Agreement) until they have conducted some due diligence and feel relatively good that it will close the transaction.
  • No material adverse change (MAC) – if something drastic happens, a Buyer wants to be able to have an out. A no material adverse change, or MAC as it’s commonly referred to, basically gives a Buyer the opportunity to back out of terms or transaction altogether. For example, buyout firms backed out their purchase of Sallie Mae because they said that a MAC had occurred.
  • Execution of senior management agreements (SMAs) - if the Buyer cannot agree to terms with the Seller’s key management, then the Buyer likely doesn’t want the pursue the transaction.
  • Required Consents and Approvals - Any required consents/approvals from owners, service vendors, customers, etc. This shouldn’t be surprising as a Buyer needs to ensure that the company it is buying has a stable customer base. Afterall, this is the basis for which the Buyer is buying the Target.
• Provisions That Are Typically Binding - these provisions are typically binding in a LOI so let’s walk through them.
  • Indemnification for Brokerage Fees – buyers do not want to be responsible for paying a Seller’s broker, or a person providing advice and representing the Seller. Again, this seems valid (although many small brokers will try to work this into the language in a NDA. As a Buyer, you need to be careful when evaluating businesses for sale as you want to make sure that you are not liable for a Seller’s fees).
  • Buyer and Seller Responsible For Own Broker and Intermediary Fees - basically this just means that Buyers and Sellers are responsible for paying their own fees to those companies that are helping each evaluate and investigate the transaction. Sometimes, Buyers will pay part of an audit if the Seller is a relatively small company and does not typically have audits performed each year.
  • Exclusivity – once a LOI is signed, the Buyer typically has some right of exclusivity granted. This means that the Seller cannot actively solicit other offers. Buyers obviously do not want to worry about a Seller constantly trying to find a slightly better offer during the entire process. The term is typically 30 to 45 days. Buyers will typically include language that grants them an automatic 15 day extension. The thinking on the extension is that something always arises during diligence or information takes longer than expected to gather, etc. so why not just get an extra 15 days to cover such things.
  • Non-Disclosure- Buyers do not want Sellers sharing its offer with anyone unless it’s the Sellers own advisors. Buyers will usually state that a Seller needs written consent from the Buyer to disclose any information that is not required by applicable law. This shouldn’t surprise a Seller as a Seller doesn’t want a Buyer disclosing the Seller’s information except to the Buyer’s own advisors.
  • Acceptance - Buyers do not want a Seller to have unlimited time to think about accepting an offer. Therefore, Buyers include a deadline for the Seller to accept. Typically, a Buyer will give the Seller one week to accept its LOI.
  • Governing Law – Sellers want to have the governing law where they are based or that’s more favorable to them. Buyers obviously want the opposite. Buyers (especially investment firms) come from the perspective that they buy companies for a living and thus, they cannot be expected to be familiar with all the various states laws. Therefore, Buyers argue that the governing law should be where they are located for efficiency and practicality.