Letter of Intent (LOI) must be Thorough

The importance of executing Letters of Intent (LOIs) that thoroughly address all relevant business terms cannot be overstated. The LOI should not be an invitation to further negotiate issues it does not explicitly cover. Rather, it should be the final culmination of the negotiation of business terms, leaving no room for ambiguity particularly in the important terms. While final definitive sales agreements invariably involve some negotiations between the attorneys for the seller and the buyer these should, as far as possible, be restricted to legal issues.

Tyre Kickers

Buyers, particularly public company buyers, often view the LOIs they issue and then execute as little more than an invitation to themselves (should the seller be so foolish as to agree to their terms) to “hop in and kick the tyres” through due diligence. Their LOIs often suggest ranges of purchase prices the public company buyers would be willing to pay, “depending” on what they “discover in due diligence or further examination.” Once such LOIs are executed and confirmatory due diligence has begun, sellers realize all but immediately at which end of the price range the buyers’ final offers inevitably will fall. The lower end . . . always!

Avoid the pain of renegotiating after signing LOI

The “loosey-goosey” LOIs preferred by many buyers—and agreed to by sellers at their peril—offer myriad avenues of attack by the buyer, post LOI. Balance sheet adequacy in various modes (when targets or clear formulas for establishing targets are not defined in the LOI) is attacked routinely. These formulas and targets should be agreed upon in pre-LOI negotiations and memorialized in the LOI. Buyers may also insist that “Seller’s transitional or ongoing employment compensation and its major terms will be established during due diligence.” These and other issues proposed by many buyers, as a rule, should not be allowed to be negotiated after an LOI has been executed. One way to deal with issues such as the employment terms is to shorten the 60-day post-LOI period, as it deals with these or similar specific issues. For example: The seller’s employment compensation and major terms pertaining thereto will be established during due diligence but no later than (fill in the desired number of days) days from the execution of this Letter of Intent.

Any type of LOI, in any form, that allows any prospective buyer such post execution latitude in revisiting and renegotiating business terms must be avoided at all costs and whenever possible, even when the seller has few prospective buyers on the horizon. Only under the most difficult of circumstances—the availability of virtually no other prospective buyers, or the seriously weakened and/or deteriorating circumstances of a seller’s company, for example—should such LOIs be entertained, because they otherwise offer little upside to sellers.

In sum, every substantive business term should be covered in the LOI prior to its execution. This includes exact purchase price, form of the transaction (stock or asset deal and compensation mix), any contemplated buyer’s tax elections of potential concern to the seller, exact formulas for earnouts and balance sheet targets, interest rates, and other payment terms, and possibly the main terms of post-transaction employment agreements.

“Honey I did the deal”

When executing an LOI, ensure that it is as thorough as possible. The seller should be able to go home and say, “Honey, I did the deal,” fully confident that he knows virtually all the terms of the soon-to-be-consummated transaction, and essentially the exact bottom-line dollar value of the deal to him. If the seller cannot go home fully confident of most of these details, he has not completed a thorough LOI and he has violated—or is at serious risk of violating—the “Honey, I did the deal” rule.

Extracted from Roberts, Dennis J.. Mergers & Acquisitions: An Insider’s Guide to the Purchase and Sale of Middle Market Business Interests . Wiley. Kindle Edition.