Thinking of Selling Your Business? Why You Should Have A Letter of Intent.*

Selling Business Letter of Intent

*Actually the title should include “…and why your lawyer should review it before it is signed”, but that was too long.

A letter of intent (referred to here as an “LOI”) is also known as a letter of understanding, a memorandum of understanding or an agreement to agree. It is a commitment between the parties to work toward a definitive purchase agreement and a closing that will be based on the terms of the LOI. It may seem counter intuitive to have two agreements for one deal, the LOI and then the definitive agreement, but the LOI is useful for the parties to set out some key terms of the deal before incurring unnecessary costs. To begin, the LOI gives the parties an opportunity to sort out what is being purchased and from whom. Will this be a share or asset deal? Is the purchaser buying the operating company only or will some holding companies be included? Are
there multiple sellers, and are they individuals, companies, and/or spouses or family trusts of the principal operator(s) of the business? These details will be important for properly preparing the definitive agreement and getting the appropriate tax advice. It also allows the purchasers to focus their due diligence from the outset.

The LOI is broken into two parts, one is the “non-binding” section, containing terms of the deal such as price, conditions for closing, and some specific representation and warranties to be included, and the other part contains the “binding” terms, such as confidentiality, exclusivity, and costs. The quotation marks around “non-binding” are there on purpose; although the terms of the deal could change throughout the course of negotiations between signing the LOI, signing the definitive agreement and closing, once the LOI includes those terms and it is signed, it is often difficult to deviate
from them. This is the most important reason for having a lawyer review the LOI before it is signed.

The LOI should include a calculation of the purchase price. A hard figure may not be possible to determine before the due diligence is complete, but a formula for the final value can be settled in advance. The LOI can also identify what the contemplated adjustments will be.

Some preliminary due diligence will have taken place before the LOI is signed and the parties may be able to identify some specific conditions that need to be fulfilled prior to closing. These conditions could include the consent of certain customers or suppliers, the acceptance of continued employment by key employees, the assignability of a government issued licence, the payout of bank debt or other liabilities, the renegotiation of a lease,
or financing for the purchaser.

Before the LOI is even contemplated, the parties should enter into a non-disclosure agreement. The LOI will then confirm the terms of that non-disclosure agreement or provide further terms for confidentially of the material exchanged. This is vitally important because it is not uncommon for an interested purchaser to be fishing for information of a competitor with no intention of closing. The LOI should go a step further to protect the seller and target business and include a nonsolicitation of suppliers/customers.

Although there is no obligation to negotiate in good faith, the parties should be bound by the LOI to work in good faith toward preparation of the definitive agreement and towards closing. This may include a period of exclusivity where the seller will not entertain offers from other interested purchasers, as well as providing open, while still commercially reasonable, access to records of the target for proper due diligence to occur.

If the LOI is terminated and a definitive agreement is not ultimately entered into, the LOI can provide for what happens at that time. Along with the return or destruction of all exchanged confidential information, and any ongoing non-solicitation covenants, the LOI may also prescribe a break fee payable to the seller by the purchaser. This is a set fee that covers the costs incurred by the seller during this time when it was subject to this exclusivity period. The break fee can also be payable to the purchaser by the seller if the seller is the one to terminate the relationship. Alternatively, the LOI may state that each party is responsible for their own costs regardless of who calls off the deal.
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The LOI is therefore a useful tool in shaping negotiations and focusing the parties’ attention on the key elements of the deal. It should be more than just a few terms jotted down on a piece of paper and requires some careful consideration before it is signed.

If you have any questions relating to any of the above, please do not hesitate to contact Sarah MacDonald at smacdonald@kmblaw.com or 905.276.0416.