Understanding Letters of Intent in Acquisitions

In the world of corporate acquisitions, a letter of intent (LOI) serves as a foundational document that outlines the preliminary understanding between a buyer and a seller before they formally finalize the transaction. Though typically non-binding, an LOI plays a critical role in setting expectations, guiding due diligence and facilitating negotiations. This article explores the purpose of LOIs in corporate acquisitions and highlights their key components.

Purpose of a Letter of Intent

A letter of intent marks an early stage in the acquisition process. Its primary function is to summarize the main terms that the parties intend to include in the definitive purchase agreement. While not usually legally binding—except for some provisions such as confidentiality or exclusivity—it acts as a “roadmap” for the transaction and reflects a shared commitment to move forward in good faith.

Key purposes of an LOI

Clarifying Deal Terms: It allows both parties to align on critical terms, such as price, structure, and timing, before investing significant time and resources in due diligence or drafting legal documents.

Facilitating Due Diligence: Once the LOI is signed, the buyer typically gains access to confidential information about the target company to evaluate its financial, legal, and operational health, known as the “due diligence” process.

Establishing a Timeline: An LOI often includes a proposed timeline for completing due diligence and executing the definitive agreement, helping to keep the process on track.

Minimizing Misunderstandings: By documenting the parties’ intentions, an LOI reduces the risk of confusion or disputes during negotiations.

Securing Deal Exclusivity: Buyers often seek a temporary exclusivity period during which the seller agrees not to negotiate with other potential buyers. This protects the buyer’s investment in due diligence.

Key Elements of a Letter of Intent

While the structure and content of an LOI may vary depending on the size and complexity of the transaction, certain elements are typically included:

Purchase Price and Structure: The LOI outlines the proposed purchase price and how it will be paid (e.g., cash, stock, assumption of debt). It may also indicate whether the transaction is an asset sale or a share sale.

Key Terms and Conditions: This includes important deal points such as escrow arrangements, earn-outs, or working capital adjustments.

Due Diligence: The LOI defines the scope and duration of the buyer’s due diligence investigation, including access to company records, management, and facilities.

Confidentiality: This clause protects sensitive information shared during negotiations and is typically binding.

Exclusivity (“No-Shop” Provision): An exclusivity clause, if included, restricts the seller from soliciting or engaging with other potential buyers for a specified period.

Closing Timeline: The LOI often outlines a target date for signing the definitive agreement and completing the transaction.

Binding and Non-Binding Provisions: The LOI must clearly state which sections are legally binding and which are not. Typically, terms like confidentiality, exclusivity, and governing law are binding, while the rest of the LOI remains non-binding.

Termination: The document may specify the conditions under which either party may withdraw from the process.

Conclusion

Although a letter of intent is usually non-binding, it plays a pivotal role in corporate acquisitions by defining the framework for further negotiation and due diligence. It allows both buyer and seller to assess alignment and feasibility before making a full legal and financial commitment. A well-drafted LOI not only helps prevent misunderstandings but also lays the groundwork for a smoother, more efficient deal process. For this reason, it is a good idea for the parties to an acquisition to draft an LOI, but also essential that they approach its drafting with careful thought and appropriate legal guidance.

If you have questions about letters of intent, feel free to contact Mark Spitz at Spitz Legal Counsel LLC, 720-575-0440 or mark@spitzlegalcounsel.com.