Letters of Intent In the Mergers and Acquisitions Process

Hi everyone, hope you’re having a great week. Today we’re going to talk about LOIs – or letters of intent – and how they’re used in the merger and acquisition process. If you’re going to be involved in M&A in any form or fashion you need to understand LOIs, you will run across them.

First a few words about me I’m Brett Cenkus. I’m a business attorney. I do that from my practice Cenkus Law. I’m also a startup and business consultant and I do that out of my brand The Startup Shepherd. A large part of what I do is mergers and acquisitions. I’ve done it at very high levels – billion-dollar, front page of The Wall Street Journal kind of stuff. In my life today, I’m involved with much smaller deals – half a million up to about 20 million dollars; what they call the Main Street part of the market which is under about 2 million bucks up into the lower-middle market. The lower-middle market people will say generally runs up to about 50 million, so I kind of play in that lower-half of the lower-middle market, if you will.

There’s a saying in the industry that the only difference between a billion dollar deal on a 10 billion dollar deal is the number of zeros to the left of the decimal place, and there’s some truth to that. The structure and what’s going on is very similar. Of course, they’re lawyered differently, the players are different, the amount of money at stake, what’s being purchased, how the deals are structured – there’s differences. And, this content really is squarely aimed at that Main Street lower-middle market half a million to 20 million dollar kind of range.

So, let’s get right into it LOIs, letters of intent – you need to understand them if you’re going to be involved in mergers and acquisitions. I get asked all the time “What are these?” “How do they work?” “Do I even need one?” So, a letter of intent is a short document – a couple of pages, they’re rarely longer than about 10 pages – that lay out the key terms of the deal.

Let’s take a look at some standard questions I ask myself when composing a letter of intent. Regarding purchase price: how much is the buyer paying? How is the buyer paying? Is it all in cash? Is the seller going to hold a note, carry back some financing? What exactly is the buyer purchasing? Are they buying the assets of the business? If so, is it all the assets or is the seller going to hold on to some? Is the buyer purchasing the stock of the business of the target? Is it actually a true merger? Although, there’s not that much merger activity at the segment of the market that I’m talking about, the sort of lower end of the market. They’re very tax-driven and don’t show up on kind of smaller deals. But, it’s worth considering the structure of the deal. What about employees? Are the employee is going to go work for the buyer after the closing? Are there conditions to the closing, things that are in the buyers mind that need to prove to be true during the due diligence period for the buyer to be willing to close the deal?

In letters of intent, there are two provisions – exclusivity and confidentiality – that are almost always included. Exclusivity says that the seller will not talk to other parties, will not continue to shop their deal for some period of time – commonly 60 or 90 days. It can be a little bit longer depending on the situation. Confidentiality is really the buyer’s agreement, although, the door swings both ways, but it’s really the seller’s concern that the buyer won’t use the information disclosed to them by the seller during the due diligence period other than deciding whether or not to do a deal – it won’t disclose that information to anyone else. A lot of the information the seller will share is going to be non-public and sensitive information.

Those are kind of the general provisions or terms in a in a letter of intent – almost entirely non-binding, which means that most of those terms are just intent. They’re just what the parties intend to agree to in the future, hence the term letter of intent. The provisions about exclusivity and confidentiality, those are usually binding and usually the only two binding terms in a letter of intent. The rest of it – no legal force or effect. So it begs the question, “why even use them if it’s all non-binding?” It’s a very good question.

Generally, I use letters of intent in three situations. One is we want to be absolutely sure the parties are on the same page. So, it’s a complex deal there’s a lot of moving parts. We want to make sure that we use our time efficiently – the lawyers that is – when we start to put together the documents. Let’s be sure that there’s a meeting of the minds on the main provisions. Secondly, to see that the buyer’s serious. Although LOIs are non-binding other than these two provisions, most buyers aren’t going to sign something unless they’re moving forward in good faith, unless they’re serious about trying to get a deal done. Lastly, if we just need to get something done and show some movement. We want to make sure we got stuff moving along – the purchase agreement for one reason or another is going to take a long time to draft and negotiate. This is a quick way to show a little bit of movement and keep things going and sometimes that’s important for the process.

But, I’ve got clients who use them and don’t use them. To me they’re useful in certain contexts and not others. I have clients who are categorically opposed to them, others who always want to use a letter of intent. I’m curious, if you’ve been involved in M&A you’ve certainly stumbled across letters of intent, do you think they’re useful? Are they important, are they worth the time and the money that goes into them? Let me know. If you want to learn anything else about letters of intent or mergers and acquisitions generally, startups and other business issues, please get in touch.