Making Sense of the Letter of Intent

Making Sense of the Letter of Intent

We first explain what can be included in an LOI, then go into the standard requirements and suggested best practices further down the page.

An Letter of Intent is often misunderstood in the sale process of a company.

The purpose of an LOI is to establish a general framework for the price and key terms of a potential transaction.

An LOI would often be executed following a verbal offer of price and terms from a buyer prospect and would be executed before due diligence starts.

While an LOI resembles a written contract, they are typically non-binding on the parties in their entirety. You could think of it as a letter of understanding to continue the process.

It is important to make sure that a potential buyer submits
an LOI before allowing them to start the due diligence process. The main reason is to ensure that you have a general understanding and agreement with the terms of their offer.

There is no sense in stalling the sale process for 90 days and giving exclusivity to negotiate contract terms with only one buyer if their terms are not going to be acceptable to you.

Why you should request an LOI

The act of submitting an LOI requires higher level approval and signature, which indicates that it is a serious offer and that the buyer representative has the appropriate authority. At the same time, the buyer is not committed to deliver those terms and is not committed to complete the transaction.

When both sides are acting in good faith, an LOI sets up the outline of an offer and allows you to contemplate whether you want to open up your company to an exclusive period of due diligence where the buyer prospect would gain complete access to your company's financials and operations.

When sellers don't request an LOI

In an informal sales process where both parties know each other well, some sellers feel that they can gauge both the motivation and indicative terms without requesting an LOI from the buyer. We believe these situations make it even more important to require an LOI.

LOI Content

The basic provisions of an LOI typically include details of the deal structure, its terms and conditions, exclusivity and obligations of the parties. The financial terms comprise the price and terms of the deal, which may include cash, stock, earn out, warrants, options, minority or majority ownership. It should also include an overview of financing sources and leverage for the deal.

It will often also set out a general timeline of when the agreement and contract would be finalized if due diligence is completed to the buyer prospect's satisfaction.

Nonbinding Nature

Even though LOIs are considered serious agreements, many of the most important parts of the agreement are not binding. Often the only binding provision is the non-disclosure or "no-shop" provision.

Exclusivity Agreements

In consideration for the time, effort and money spent by the potential buyer during the due diligence process, exclusivity agreements are standard. The seller agrees not to market the business to other interested parties which as a consequence provides the buyer with some sort of security against competing offers. Different terms essentially all mean the same: "no-shop", "stand-still" etc.

Unfortunately for the seller, if the deal falls through after the due diligence stage, it inevitably means a loss of momentum in the sale process. This is why it is so important to have a clear understanding of a buyer's track record, financial means and motivation to complete the deal in a timely manner, as well as have some other buyer prospects in reserve if the current buyer falls through. Without that assurance, many sellers tie themselves into "no-shop" agreements with buyer prospects that talk a good game, but are unlikely to ever get to the finish line.

Reliable Financial Data

Even though an LOI is a significant step towards the sale of your business, it is just the first step in negotiations. As price and terms of the LOI are not binding, this is when the work really begins to provide accurate and reliable data in a timely manner. If you have an acceptable buyer prospect, you need to increase their confidence in your company by pre-empting their due diligence requests with thorough preparation and a secure data room available to them with information they are likely to request.

And a final note. If a buyer requires you to disclose sales forecasts before the LOI is signed, make sure that they are reasonable. If you are too optimistic, the buyer will often use your non-achievement of the forecasts as leverage to renegotiate the purchase price, worsen the terms or both.

All rights reserved. Copyright: ClearRidge Capital, LLC, 2009.

About ClearRidge Capital
ClearRidge Maximizes Enterprise Value as a business, financial and strategic advisor to midsized US companies. ClearRidge’s Directors have completed over 200 MandA transactions, provided restructuring advice and secured new and replacement debt and equity for companies across the US and Canada.

Mergers and Acquisitions includes buying, selling, merging and valuing midsize companies. Restructuring includes financial, operational and strategic restructuring. Corporate Finance includes advisory for raising and replacing debt and equity to provide the lowest cost of capital. Turnaround, Bankruptcy and Crisis Management services include debtor and creditor advisory, bankruptcy support and turnaround management. We provide top tier advice and relationships with Middle America values.

For further information, visit www.clearridgecapital.com