In mergers and acquisitions, a letter of intent often signals the transition from casual discussions to serious deal negotiations. A letter of intent (LOI) by no means that the deal is finished. But it does lend a tone of seriousness to the deal, and can help both parties negotiate in a more constructive fashion. Before signing a letter of intent, or writing one with the assistance of your lawyer, here’s what you need to know.
LOIs Don’t Close the Deal
Unless the terms of the LOI specifically state otherwise, an LOI does not require either party to close the deal. Instead, these contracts outline the criteria under which the parties are willing to negotiate the deal. They may include non-disclosure agreements, deadlines for watershed moments in the negotiation process, or a list of people permitted to participate in the negotiation process. But until the deal closes and the contracts are signed, a sale is not inevitable.
An LOI is a Formal Legal Document
Although an LOI is not the same as a sales document, it is a formal legal contract. That means it’s enforceable in a court of law. LOIs may outline penalties for violations of confidentiality, set deadlines for key decisions, or even require the payment of a deposit at a specific point in the process. This offers significant protections to both parties. It forces each side to take the deal seriously, prevents wasted time and effort, and provides legal recourse if one party harms the other during the process of negotiations and closing.
Like any legal document, an LOI should be reviewed by an attorney. Always read the LOI in its entirety so you don’t find yourself ruled by terms you never knew existed.
You Don’t Have to Sign an LOI
Negotiating a deal doesn’t mean you have to sign an LOI. If both parties feel comfortable working with one another, they might forgo the LOI and proceed to transactional documents. Doing so certainly saves time, since an LOI is a contract that must be negotiated.
Depending on the dynamics of the deal, the personalities of the party, and each party’s goals for the transaction, however, an LOI can lead to a smoother negotiation process and a better deal. LOIs can preserve confidentiality, set expectations, and help parties negotiate in good faith.
LOIs Set Due Diligence Standards
Without an LOI, due diligence is whatever the parties say it is. If there are different expectations about the process of due diligence, the deal can break down or stall at this point. LOIs set standards and expectations. Doing so early in the process can help each party determine what fair due diligence looks like. Knowing what to expect can also help the seller prepare for due diligence so that there are no costly and unpleasant surprises.
LOIs Protect Both Sides
LOIs are particularly helpful to sellers, who may be concerned about confidential company information being disclosed to third parties. But an LOI isn’t just for sellers. These documents protect all parties to the deal by clearly outlining rights and obligations during the deal-making process. These documents may include no-shop provisions, or prevent uncertain sellers from wasting a buyer’s time by setting clear deadlines or ensuring an exhaustive process of due diligence.
LOIs can even contain a breakup fee if the deal breaks down under circumstances outside of those permitted in the agreement. This protects both parties’ time investment in the deal, and can alleviate stress for everyone involved in the process of negotiating the transaction.