Part II in a seven-part series on the anatomy of an M&A transaction from the sell-side perspective. To read Part I, covering the basics of pre-transaction planning, click here.
Most mergers and acquisitions (“M&A”) transactions commence in earnest with a letter of intent (AKA a term sheet). As the name implies, a letter of intent (“LOI”) is a written document that outlines the intentions of the buyer and the seller during a transaction. Simply put, the LOI is the roadmap to the transaction. Among other matters, the LOI will include the purchase price for the subject business (and the associated payment terms) as well as the other key considerations and conditions to the transaction. In the end, the LOI is a written expression of the buyer’s intentions to purchase your business and with its submission to the seller indicates the buyer’s intentions for the deal.
The LOI is a very important document. It should be in writing and it should be carefully crafted. Unlike a typical contract, the terms of an LOI are frequently non-binding on the parties except as specifically called out in the LOI. (Note: Some courts, however, may interpret a LOI as a binding document if one or both parties treat it like a contract, so it is critical to be careful when drafting and negotiating a LOI.) Thus, sellers need to beware that the terms contained in the LOI may not be the terms that the buyer and seller ultimately settle upon on the closing date. In fact, for sellers, the details in the LOI may represent the best terms such seller can expect from the given buyer.
Naturally, buyers put their best foot forward when submitting the LOI for the seller’s consideration—and the LOI is generally submitted prior to substantial due diligence on the seller by the buyer. Hence, the terms in the LOI usually represent the buyer’s best “guesstimate” as to the terms it is willing to purchase your business. But recall that most provisions included in the LOI are non-binding; thus, do not be fooled that the terms set forth in the LOI will be the final terms. In fact, after the buyer conducts diligence, the buyer will frequently “tweak” the terms of the LOI (which could include adjustments to the aggregate purchase price and the terms of payment).
When properly used, a LOI protects you, the seller, and your buyer. Poorly-drafted LOIs, on the other hand, may cause negotiations to fall through at minimum, or, in a worst-case scenario, lead to a costly legal battle if expectations are not defined at the outset.
Recall the first rule of an M&A transaction: You have not sold your business until you have sold your business. Consider the LOI the initial expression of the intent by the parties to consummate a mutually beneficial transaction. Do not be lulled into thinking that executing the LOI translates to the sale of your business. It does not. Usually, there is still much work to be accomplished and hurdles to overcome before the sale is consummated.
So, as a seller, what should you get down in writing in your LOI? Which clauses are most important down the road? In addition to the purchase price and the terms of payment (which are very important), below are three other key areas for any LOI.
During the sale of your business, you will not only need to disclose sensitive information to your buyer but handle your buyer’s confidential information as well. It is crucial to determine what information is allowed to be disclosed and to whom. Your buyer may need to share information about your business with their accountant and legal counsel, for instance, in order to accurately assess the value of the sale. Beware of unilateral confidentiality agreements. If the other party is unwilling to disclose confidential information of their own, it may be a sign your “buyer” is on a fact-finding mission rather than pursuing a sale.
In most states, parties on either end of a deal are obligated to negotiate in good faith – that is, honestly and fairly, with no one party taking advantage over the other. While agreeing to “good faith” language often helps your buyer feel more confident in the deal, doing so puts you at a disadvantage. For example, your buyer may claim bad faith if you choose to back out from a letter of intent. It is never a bad idea to expressly state whether you choose to negotiate in good faith, or outright disclaim your duty to do so. If you are unsure whether you are ready to complete the sale, avoid agreeing to negotiate in good faith.
An LOI typically includes an exclusivity provision, in which the buyer asks the seller not to negotiate with any other prospects for a limited amount of time. Sometimes referred to as a “no-shop” clause, exclusivity agreements lock sellers up in LOIs, thus decreasing your leverage during the duration of the agreement. As a seller, it is in your best interest to ensure the exclusivity period is as short and the terms meticulously defined as possible. Consider what you get in exchange for taking your business off the market. What benefits do you gain in regards to price, escrow, warranties, and so on?
Once both parties sign the LOI, the buyer will conduct due diligence on the seller’s business. Most LOIs will outline this process: the matters investigated and the extent of the investigation. In my next article, I will examine the role of due diligence in the overall anatomy of a deal from the seller’s perspective. At any stage in the selling process, an experienced business transactions attorney is a must.
ABOUT MIKE MERCURIO
Michael N. Mercurio is a leading attorney in the field of mergers and acquisitions (M&A). He serves as outside general counsel in buy-side and sell-side M&A, as well as in all business law and real estate law matters. As a strategic partner to firm clients, Mr. Mercurio regularly counsels entrepreneurial individuals and assorted entities on the many challenges, issues, and opportunities companies face throughout the business lifecycle—from start-up to eventual exit.
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