Letter of Intent: The What, Why and How
What is a Letter of Intent?
A Letter of Intent (LOI) is a specific document that outlines and sets forth certain basic terms upon which two or more parties intend to enter and formalize into a more binding definitive agreement in the future. LOI’s are usually non-binding, which solidify “handshakes” made between parties. They are similar to heads of agreement, memorandum of understanding, or a term sheet and is a starting point between two parties used in negotiating a variety of business arrangements such as mergers, acquisitions, agreements, contractual agreements, etc. They are pre-contractual documents that clarify the parties’ intentions and set forth certain basic terms and provisions upon which parties intend to enter into binding definitive agreements.
The overall letter is not intended to be binding to both parties but some of the provisions of the letter may be binding. The binding terms in the letter should be stated clearly while clarifying the letter is not a definitive agreement. Failure to adhere to the binding parts of the agreement by any party will result in legal actions and, that is why it is essential to understand the components of the Letter of Intent.
Why should you have a letter of Intent?
The LOI is a record of the progress of the initial negotiations and is used to identify, setting out, and resolving essential terms of the transaction and items to reach a preliminary agreement.
- LOI highlights and defines time frames and deadlines, avoiding pitfalls that can often stop the transaction from moving forward.
- A successful LOI mitigates risk and avoid both buyer and seller spending significant legal fees and management resources.
- The buyer can use LOI to obtain financing from a lender.
- LOI establishes good faith between parties. Although most of the terms are not legally binding, it shows commitment to each other.
- LOI is often used as a guide to the final deal and can be shared between shareholders who don’t need to comb through whole documents to get an idea of essential terms. A well-drafted and signed LOI can provide each party’s legal teams and other professional advisors a guide to prepare and negotiate the final agreement.
Components of a Letter of Intent:
Depending on the negotiations between the parties, a LOI can be either short or long, but should include the following sections.
This section should include the purpose of the document and also state the date when it becomes effective. Various terms can be defined here.
Identification of Parties:
The buyer and seller (or the parties involved in this venture) are clearly identified and listed.
Transaction and Timing:
This section should list the nature and structure of the acquisition. If possible, it should also name a suggested purchase price. This section is where the deadlines for completion of specific steps, while still allowing for the possibility of extensions if both parties agree are listed.
Details about securing finances, the approval of a board of directors, or shareholders are listed here. This section is where the parties agree on which state laws are applicable to cover the final agreement.
In this section, the buyer describes what actions he or she will take during the due diligence process — such as checking records, requesting and reviewing financial documents, assessing employment contracts and assessing the value of specific business assets. Liabilities and limitations are reviewed here so this due diligence process can take place in good faith.
Both and all parties involved should sign the Letter of Intent, date it, and have this document notarized.
Sometimes, a LOI can have other elements such as key contracts, exclusivity, employees, prohibited actions, and termination conditions. What you include in a Letter of Intent depends on the deal’s details and how comprehensive it should be (short form vs. long form).
Types of Letter of Intent (LOI)
- Short-form Letter of Intent
- Long-form Letter of Intent
A Short-form of Letter of Intent is a quicker to negotiate document and only addresses a few key terms. The Long-form Letter of Intent is more comprehensive with outlining issues and is designed to negotiate on key terms to reach a successful deal.
There are advantages and disadvantages, and a key to choosing is keeping in mind how much time you have, the need for the increased momentum to get a deal done and the relationship between parties whether they are ready to deal with difficult and time-consuming issues early on.
Terms of the Letter of Intent – Binding vs. Non-Binding
A well-drafted LOI can make a successful acquisition with parties agreeing on optimal terms. While an LOI is a legal agreement between two parties, it is not typically a binding agreement. However, within the LOI document, naturally, you will find specific terms that are binding for both parties. It is crucial to understand and worth further exploration. Lack of clarity and understanding of what is binding or not, might allow the matter to be taken to court.
The following aspects of an LOI can be binding:
- Expenses: Sharing or covering of each parties’ costs outlined in the LOI are binding.
- Confidentiality: The terms agreed between parties are confidential and are typically subject to a non-disclosure agreement between the parties
- Dispute Resolution: An LOI typically states both parties agree that any disputes that arise would be resolved by binding arbitration confidentially.
- Exclusivity: The LOI grants the terms of exclusivity to the buyer, and this is a binding term.
Alternatives to LOI:
- Term Sheet: Like the LOI, a Term Sheet is a non-binding expression of interest by a buyer that outlines the price, the structure of a transaction and is less comprehensive than the LOI.
- Expression of Interest (EOI): The EOI letter typically expresses the buyer’s capabilities to buy the business and a range of value they would be willing to entertain offers.
- Memorandum of Understanding (MOU): MOU is a document that broadly outlines of an agreement that two or more parties have reached. The primary difference between an MOU and LOI is that the former is binding and is legally enforceable.