M&A transactions are often complicated affairs, involving a number of different parties, workstreams, and documents. An M&A letter of intent can serve as an effective roadmap for a transaction and ensure that the parties are generally aligned on the deal terms, at least at a high level, at the outset of the transaction process.

What is an LOI?

A letter of intent, or term sheet (interchangeably, an “LOI”), is often the first significant document for an M&A transaction. The LOI, although generally non-binding except for certain provisions such as “exclusivity”, is the parties’ first expression of what they anticipate the ultimate deal terms to be. An LOI can be a simple one page document or a more complex multiple page document with exhibits, but all LOIs will set forth important economic and other terms of the proposed transaction.

Key Components of an LOI

1. Purchase Price and Transaction Structure: The first substantive item in an LOI will typically be the purchase price and a general description of the transaction structure. In more complex and larger transactions, there will likely be more detail around the buyer’s anticipated sources of financing for the transaction. For example, the LOI may set forth whether the transaction will be financed through equity, debt, cash reserves on hand, or a combination of any of the foregoing. The financing combination of debt/cash reserves will represent proceeds immediately available to seller at closing (subject to payments/deductions for any pre-closing debt, and escrows/holdbacks, etc.), while “rollover equity” will represent the portion of the purchase price that will be paid to seller in the form of equity interests of the buyer or buyer’s holding company.
2. Fundamental Deal Points: An LOI will typically outline other fundamental deal points, such as the purchase agreement terms, treatment of real estate, plans for employees, and restrictive covenants (e.g., noncompetes). The parties may also include in the LOI an estimated timeline for the transaction or individual workstreams within the transaction.
3. Expenses, Confidentiality, Governing Law, and Exclusivity: An LOI will often address issues such as who will bear the expenses of the transaction, confidentiality obligations of the parties, governing law, and an exclusivity provision. It’s important to note, that all other terms of the LOI previously discussed are typically considered “non-binding” in that they are not legally enforceable as contractually binding the parties; however, the provisions relating to expenses, confidentiality, governing law, and exclusivity are typically expressly stated to be binding/enforceable on the parties. The most consequential being an exclusivity provision, which sets forth a durational period during which the seller agrees not to solicit bids from, or even have discussions with, other potential acquirers during that period of time.

Legal Points of Negotiation in an LOI

Almost certainly, an LOI will also discuss certain points of a purchase agreement, including, but not limited to, how the arrangement is structured (i.e., as an asset vs. equity deal), any assets/liabilities that will be excluded from the transaction, indemnification baskets/caps/survival periods, whether there will be any escrows or holdbacks and corresponding amounts, and other key transaction terms. More in-depth LOIs will potentially detail further how the purchase price might be allocated from a tax standpoint, what representations and warranties may be considered “fundamental”, and potentially define key terms that will be used in the purchase agreement such as “indebtedness” or “working capital”, which can have material economic consequences to the relevant parties.

From a legal perspective, it’s advantageous for both buyers and sellers to do much of the back and forth negotiating around the economic and legal points of the transaction as a whole and within the transaction documents up-front in negotiating the LOI. Oftentimes, this will include the key points in various ancillary transaction documents. For example, if the transaction contemplates a real estate lease, the LOI should address terms such as the duration of the lease, rent, rent escalators, rights of first refusal, and other high-level items. If the transaction contemplates employment and/or consulting arrangements, the LOI should address terms such as title, duties, duration, and compensation. And, if the transaction contemplates seller “carryback” financing, the LOI should address payment terms, interest rates, collateral, and guaranties. These are just a few examples of ancillary transaction documents, but each transaction is unique so consideration should be given to any arrangements a party feels are important to the overall deal and address such arrangements in the LOI as necessary.

It’s important to involve third-party advisors to assist with negotiating the LOI to help gain the most advantageous results. Legal counsel and other third-party advisors can help negotiate “market” terms or even more favorable terms based on the likely leverage that exists during this phase before an LOI is signed and exclusivity goes into effect. Although the substantive components are not binding within an LOI, it can strain a potential transaction if one party repudiates a negotiated item within an LOI down the road. Legal counsel and other third-party advisors can also assist with issue spotting and identifying potential hurdles that may impede on the deal, that way those issues can be addressed and hopefully resolved before all parties incur significant expenses.

Often, doing much of the “leg-work” up front and negotiating a detailed LOI facilitates a streamlined transaction that gets the parties to the finish line sooner and more efficiently.

Need help drafting an LOI for your M&A transaction?

A well-structured letter of intent can set the stage for a smooth transaction and align expectations early in the deal process. Our M&A attorneys provide regular guidance throughout this process and are here to help. Explore our M&A practice to connect with a member of our team today.

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