A letter of intent (LOI) is a meeting of the minds between the buyer and the seller. Although it is generally non-binding, it is the foundation attorneys will use to develop the binding purchase and sale agreement (PSA). Therefore, the LOI should include all relevant business terms that are part of the deal with enough details to prevent any misunderstandings later in the process. You can also save on attorney fees if the LOI is complete, because otherwise your attorney may need to spend significant time negotiating those terms for you.
A good LOI should be something your attorneys can easily understand and incorporate into the PSA without having to negotiate any business terms. If a buyer says “Let’s leave that vague for now and we’ll refine it in the PSA,” be very cautious. Either they don’t know what they’re doing, or they just want to get past the LOI stage so they’ll be the only buyer left in the process and have more leverage to negotiate important issues.
The Anatomy of an Effective LOI
The buyer usually presents the LOI to the seller, but if they or their attorney are not accustomed to doing deals, they may not be aware of all the elements of an effective LOI. At a minimum, insist it address certain items, such as:
1. Purchase price, how and when it will be paid, and the source of financing
2. Stock sale vs. asset sale
3. Allocation of purchase price for asset sales (depreciation recapture can have a huge impact on the taxes you owe)
4. Terms of seller notes or earnout (if any)
5. Real estate lease details if seller is leasing facilities to the buyer
6. Transition expectations for previous owners—how long, what are their roles, compensation?
7. Working capital (how much is included and how is it defined?) and will receivables be guaranteed?
8. What assets and liabilities are included and excluded (do you intend to keep your Lexus that’s on the balance sheet)? It’s a good idea to attach a recent balance sheet to the LOI and indicate who gets what
9. Is there excess cash, who gets it and how is it defined?
10. Specifics of any non-compete agreements
11. Any contingencies—employee interviews, financing, assignment of contracts, phase two environmental site assessment, etc.
12. Holdbacks or any non-standard representations, warranties or indemnifications (you need a good deal attorney on your side to understand what is standard)
13. Due diligence timing and requirements
14. Will a quality of earnings report or other level of financial review be required and who will pay for it?
15. When will certain sensitive information such as detailed customer lists be shared? Waiting until after the PSA is signed or even after money is in escrow prior to close might make sense
16. Expected closing date
17. An exclusivity period is common, but make sure it has a time limit (say 75 days) where you can go talk to other buyers if things aren’t working out
18. Timing on announcements to employees, suppliers and customers
This is not a complete list, but covers many of the common terms that should be addressed. The less both buyer and seller assume, the better.
Ensure you consult your attorney and tax advisor before signing a letter of intent. A detailed LOI will benefit all parties involved and greatly increase the chances that the deal makes it all the way through closing, which is what everyone wants.