Understanding the Letter of Intent in M&A:

A Letter of Intent (LOI) is an important document in the mergers and acquisitions (M&A) process. It serves as a formal, yet mostly non-binding agreement between the buyer and the seller, outlining the main terms of a proposed deal. The LOI details the structure, pricing, and significant conditions of the transaction and sets the groundwork for subsequent negotiations.

This section will explain how letters of intent (LOI) are used in M&A deals.

To start with, when a business owner decides to sell, they typically engage with an M&A advisor who will act as an intermediary between the seller and prospective buyers and will drive the M&A process for them.

In the initial stages, an M&A advisor's primary tasks involve conducting a market-based valuation of the seller's business and creating compelling marketing materials. These marketing materials aim to attract multiple competitive buyers to participate in an auction, fostering a bid process that encourages buyers to actively compete with each other, driving the purchase price up.

These marketing materials typically include a teaser and a confidential information memorandum (CIM).

Once the M&A advisor has set up an auction and brought several interested buyers together to make offers, the bid process starts. The bid process typically involves prospective buyers submitting initial non-binding offers, to the seller's M&A advisor. These initial offers are called Indications of interest (IOIs). From here, the M&A advisor will eliminate some candidates, encourage others to make stronger offers and narrow down the candidate pool further. Once there is a highest and best offer that the seller accepts, that prospective buyer will submit a letter of intent.

The bid process typically starts with the IOI and ends with the LOI. The letter of intent is a document, written as a letter from the buyer to the seller outlining the prospective buyer's offer and crystallizing key points discussed up until this point.

After the LOI is signed by both the buyer and seller, the formal Due Diligence process begins.

What Should Be Included In A Letter Of Intent?

Now that we've seen how LOIs come into play in M&A deals, we'll look at what is typically included in letters of intent here.

In a nutshell, the Letter of Intent in M&A serves two primary purposes: it outlines the skeleton of the agreement and creates a safety net for the buyer during the due diligence phase. It's a critical step in turning discussions into a potential deal, striking a balance between intent and flexibility.

Remember, that the letter of intent is not the final, binding agreement. It serves as a preliminary agreement between the buyer and seller before a detailed contract (Definitive Purchase Agreement) is drawn up.

Here are some elements that are typically included in an LOI:

1. Purchase Price and Terms: This is the proposed price and the structure of the deal. It's common for the LOI to include the intended purchase price, the terms of how that payment will be made (upfront cash, earnout, etc.), and considerations for the structure of the deal (ie. asset vs stock deal).
2. Proposed Closing Date: This part will include a projected date for closing the deal and it will also normally look at what needs to happen (ie. approvals and consents) to get the deal closed.
3. Conditions Precedent: These are conditions that must be met for the deal to proceed. They could include regulatory approvals, financing agreements, or other specific prerequisites.
4. Due Diligence: There will be a clause outlining the buyer's right to perform due diligence before finalizing the agreement. Often prospective buyers include a list of items for their formal due diligence.
5. Indemnification Provisions: These protect the buyer from any potential post-closing losses due to breaches of representation or warranties by the seller.
6. Confidentiality Agreement: Given the sensitive nature of M&A deals, a confidentiality clause is usually incorporated to protect the information shared during the negotiation process. At this point, there has already been a formal NDA signed by both parties. This confidentiality provision will build on that previous agreement.
7. Exclusivity Period: This is a specified period during which the seller cannot engage with other potential buyers. This gives the current buyer a secure timeframe to complete the due diligence process. Typically a buyer will ask for a period of 60 to 120 days in order to conduct due diligence.

Additionally, prospective buyers sometimes include provisions or proposals regarding escrow payments, and representations and warranties. These are normally not fully negotiated until the definitive purchase agreement, however.

Are Letters Of Intent Binding Documents?

Since we've just seen what is typically included in an LOI, we'll move on to briefly discuss the binding nature of these documents. While most of the LOI is non-binding, there are certain provisions, such as the no-shop or exclusivity clause, that are legally binding.

This clause is particularly significant as it grants the prospective buyer a specific period of exclusivity, during which the seller agrees not to pursue new offers from other potential buyers. This period allows the buyer to conduct due diligence without the fear of being outbid by another party.

Also, any additional confidentiality agreements made in the LOI will be binding as well, as per the agreements themselves.

Recommended Resources:

• The M&A Process Explained
• Asset Purchase vs Stock Purchase
• Definitive Purchase Agreements
• Earnouts In M&A
• Non-Disclosure Agreements in M&A