Part 1: What Are Mergers And Acquisitions
Part 2: Synergies In M&A Deals
Part 3: Outline Of Business Valuation Techniques
Part 4: Quick Overview Of M&A Process
Part 5: Selling Business To Private Equity
Part 6: Selling Business To Venture Capital
Part 7: Letter Of Intent (or “LOI”) In Mergers And Acquisitions
Part 8: Due Diligence Process
Part 9: Principles Of Negotiating In Mergers And Acquisitions
Part 10: Sale And Purchase Agreement
Part 11: M&A Deal Closing
Let’s introduce you to this section on letters of intent (or LOI), often referred to also as memorandum of understanding (or MOU). The main point about these documents is that there is no unique document that you can take off the shelf and say, that is what we need for our deal. Because every deal situation is different. The LOI has its own structures, its own parameters, its own negotiating points. There is no one size fits all, and you really have to grasp that and understand that you will not get a definitive answer on how to write one of these things. Taking that point, I don’t want you to think that having gone through this article, you can write an IOI or MOU. You might have a very good idea of what goes in it, but you will not have the legal knowledge, or information to actually write a tight legal document as this is really something for your attorney to deal with.
This content is not intended to make you a lawyer. It is intended to show you what goes into it and to give you information for educational purposes only. Everything else, leave it to your attorney or lawyer to do the writing and the drafting. However, the point I want you to understand is what goes into an LOI, what can go into an LOI, and just as importantly, what you might not need to put into an LOI in your particular deal situation. If you have a very good idea of the range of options you can go to and say, yes, we need this, we don’t need that. And you also will hopefully go away with a very clear idea of why that particular point is in the document or what is the purpose of that clause and that paragraph.
And that is really important too. Bear in mind of course, that LOIs look a bit different in different jurisdiction, and that US and UK style along are very much different. But you will also see that while LOIs in different jurisdictions use a different language the substance of these letters in many cases is absolutely the same. Of course, law varies everywhere. There is no standard global law. UK law and European law is very different, and therefore you may have a clause in one jurisdiction, which is acceptable but which is possibly even illegal to put in another jurisdiction. So you do need to understand the law very carefully.
The LOI sets out the principle terms of the proposed deal to ensure that there is genuine meeting of minds on the key issues. This is the foundation on which the deal is constructed and with which relationships of trust are built that lead to successful transactions. There are long or short LOIs, reflecting two approaches to an LOI.
A short LOI simply covers the main points of the deal, which provide the negotiations with direction and momentum. These include the following headings: an introduction, a transaction overview and structure, an illustrative timetable, a due diligence process, process outline, exclusivity and confidentiality, and non-binding commitment.
A longer LOI, which covers all the major points and issues mentioned above, is more extensive and can be used to form the basis for drafting the sale and purchase agreement. You have to remember that there are four aspects to a deal, operational personnel, financial and legal, and the LOI is intended to set the criteria for all these in the deal that is being discussed.
In most LOIs there are very few binding obligations. An LOI can be binding or non-binding, and if it is non-binding, this must be clearly stated, subject to contract and due diligence or some other similar wording. If nothing is said, the assumption will be that the LOI is binding. In most LOIs, there are very few binding obligations with two key exceptions.
The benefits of the LOI are that they set the ground rules for the subsequent negotiations. It also provides a framework for negotiating and drafting of a final agreement. An LOI can save money, and it can also be used as a negotiating tool by either side. It can be used to support an application for financing from a third party, say from a bank with appropriate disclosure to the seller. Of course, it can serve to develop trust between the parties to the agreement. It may provide the basis for the buyer to commence their due diligence, which normally has costs associated with it, and it can be used to lock the seller into a period of exclusivity. The main advantage for a buyer is that they can gain this exclusivity and have a reasonable confidence that a deal can be reached on acceptable terms before investing further time and money, particularly in due diligence.
For advisors for the seller, exclusivity is generally a disadvantage. However, they also benefit from clarity on the terms of a potential deal. It also enables them to get a price in writing, which may make it harder for the buyer to change subsequently. It also creates time pressure on the buyer who needs to finalize the deal, subject to due diligence and the deal documentation before the expiry of the exclusivity period. The potential downsides of LOIs can be a waste of time and money. They may also trigger notification obligations to customers, creditors, suppliers, government, and other entities, et cetera. They may end up being binding even if the intent is to be non-binding. Finally, you must be clear in your transaction why you want to enter into an LOI. If there is not a good reason, it’s probably better not to do it. An unsigned term sheet may be just as effective.
I will now cover some of the key components of LOIs, but in no event should the information contained in this book be relied on as giving legal advice, and it should only be used in conjunction with the advice of a competent corporate or tax attorney or solicitor.
In general LOI sets out the two corporate sides of the transaction, who is buying whom and on what terms. These include the structure, the purpose of the deal, the scope of the transaction, its background and its objectives. It is important to be clear here about the precise corporate entities involved in the transaction, even perhaps to listing company numbers or places of incorporation. In the event that there is a dispute in the future, it is essential that these details are recorded accurately. The terms and conditions of the transaction are then set out in brief purchase price and terms. This section sets out the detail of the purchase price and terms, starting with the total purchase price and specifying the currency, the payment terms are laid out and may include down payment, promissory notes, terms such as interest rate, default situations, performance payments, which might be earn-outs, royalty fees, purchase price adjustments, assumptions and adjustment events and liabilities to be assumed. It may also state the allocation of the purchase price.
The valuation basis may be included to set out the main assumptions underlying the valuation of the business being bored if these subsequently change as a result of due diligence. This opens the door to a renegotiation of the price. The key assumptions underlying the valuation may include forecast EBITDA, any add-backs to EBITDA for one-offs or vendor drawings, due diligence supporting the achievability of the company’s forecasts, the company being acquired on a debt and cash free basis, a statement that the company has sufficient net assets at completion to support its normal working capital and operating requirements, and that no material contracts or other such arrangements terminate or alter adversely. As a result of the change of ownership employment agreements, the LOI should set out the buyer’s intentions to honour the existing employment agreements of the selling company’s management and staff, where senior or specific people are not expected to continue in employment with the company.
The latter point should be made very clear. Often managers exit the company on a sale, and it is important that this is handled correctly to prevent any subsequent disputes arising from employment terminations.
It is customary to reflect the future roles for the existing management team in the letter of intent. The buyer will, for the most part, wish to secure the services and the loyalty of senior staff. And the first step to doing this is to explicitly set out their future roles in LOI.
The next clause to look at is the acquisition agreement. The LOI may set out the principal objectives of the sale and purchase agreement along with any restrictions or limitations to the rights, assets, or liabilities of the company being bought. The letter should make it clear that the offer is subject to the agreement and signing of a definitive sale and purchase agreement.
Other deal specific points may include sources of funds. It may be helpful for the buyer to make it clear that they have the funds required for the deal and where these funds are coming from.
The document should also make clear at some point that the deal is conditional on warranties and indemnities appropriate to the transaction being available for due diligence review. The LOI should set out the scope for the due diligence review process. This can be general or provide specific information such as some of the examples of financial information needed by the buyer. This may include the analysis of year-to-date performance, a current run rate for the business projected outcome for the current, full year sales analysis and profitability by customer analysis, and the existing pipeline. Assessment of key assumptions for the next financial year, forecast of anticipated market growth and companies position in the market potential for expansion into new product areas and international markets.
The buyer is also likely to want to investigate the key current customer relationships and hold interviews with key customer contacts.
There may also be provisions for specific commercial legal and environmental due diligence.
A timetable can be set out explaining the key activities to be undertaken between the signing of the LOI and the completion of the transaction. In the event that the seller fails to meet the expectations of the buyer for access to documentation information or personnel, this clause can be cross-referred back to as reason for amending the timetable. The timetable may look something like this:, an initial two-week period for initial due diligence after which the offer is confirmed, an 2-6 week period of exclusivity comprising the formal due diligence period. This would also involve drafting the legal documentation, which will include the sale and purchase agreement. You may go on to explain also that the achievability of the timetable may be dependent on the timely receipt of information, and you may wish to attach a timetable as an appendix to the document with the key deliverables and milestones including a target completion date.
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