During the process of negotiating and finalizing a business acquisition, parties may sign a letter of intent that reflects their agreement on key deal terms and represents their commitment to closing the deal. As such, letters of intent represent a significant milestone in the business acquisition process.
Understanding Letters of Intent
In a business acquisition, a letter of intent (LOI) serves as a preliminary agreement between the involved parties, outlining the essential terms of a proposed transaction. LOIs ensure that these parties have a mutual understanding of and agreement on the basic terms of a deal before they devote the time and money to performing due diligence and negotiating a definitive agreement.
Although LOIs contain the primary terms of a contemplated business acquisition, they usually do not bind the parties to consummate the deal. However, an LOI might have binding language about other matters, such as confidentiality provisions that require parties to keep information disclosed during due diligence confidential or exclusivity provisions that require the parties to negotiate with each other for a specific period and to do so in good faith.
Typical Components of an LOI
Typical provisions of an LOI for a business acquisition include:
- Price and payment structure: An LOI may outline the purchase price for the business and detail the key aspects of the payment structure (e.g., cash, equity compensation, promissory notes, post-closing earnouts).
- Key deal terms: LOIs may specify other critical terms of the transaction, such as the timeline for due diligence or closing contingencies.
- Confidentiality: LOIs frequently include non-disclosure provisions that require the parties to keep all information disclosed during due diligence or the terms of the LOI confidential.
- Exclusivity: An LOI may include a “no-shop” clause that prohibits the seller from negotiating an acquisition with or entertaining offers from other parties besides the contemplated buyer for a specific period.
- Due diligence: LOIs may include provisions governing how the parties will conduct due diligence.
- Termination and expiration: The LOI may specify an expiration date after which either party can withdraw from the proposed deal, or outline the terms under which either party may terminate the contemplated acquisition.
The Importance of LOIs in Business Acquisitions
Parties typically treat LOIs as a milestone in the process of consummating a business acquisition, as these documents serve several critical purposes. LOIs provide a roadmap for the proposed transaction, including furnishing the key deal terms for the parties to incorporate into the finalized contracts and establishing other procedures for due diligence and closing. LOIs help avoid misunderstandings as parties negotiate the finalized agreements for closing, thereby making that time-consuming process more efficient. Finally, an LOI demonstrates good faith by each side, showing their commitment to completing the acquisition, which can also help the parties secure financing or approvals from third parties.
Legal and Strategic Considerations
There are several important considerations parties should keep in mind when negotiating and drafting LOIs in business acquisitions, including:
- Obtaining a legal review of any proposed letter of intent before signing
- Clarifying which provisions of an LOI have a binding effect on the parties
- Ensuring clarity in the terms of an LOI while avoiding excessive detail that may restrict future negotiations over a final agreement
Parties should strike a balance between including clear, explicit key terms in a final agreement and maintaining flexibility that allows them room to negotiate a mutually acceptable deal. Having highly detailed deal terms in an LOI can cause the deal to fail if a party later wants to negotiate certain aspects of the final deal, but the other party insists on adhering to those minor details.
Contact a Business Acquisitions Attorney Today
Are you in the process of negotiating a business acquisition? If so, contact Deborah Hubbs, Attorney & Counselor at Law, PL, today for an initial consultation to find out how a Houston business attorney can help you protect your financial interests.