The Letter of Intent (LOI): your roadmap in a business acquisition

What is a letter of intent and why do you use one during an acquisition?

A letter of intent (LOI) serves as a preliminary document drafted by both the buying and selling parties during the initial stages of a corporate takeover. It outlines the foundational aspects of the proposed transaction, including the expected purchase price, the nature of the deal structure, and any major prerequisites.

Beyond establishing basic terms, the LOI acts as a procedural guide for the ensuing period, covering tasks like due diligence, ongoing discussions, and the preparation of the final purchase agreement. Although often seen as a gesture of good faith, you must recognize that certain provisions within this document can carry legal weight. It functions as an essential instrument for creating order and minimizing uncertainty throughout a complicated transaction.

Non-binding or binding? The legal relationship surrounding the LOI

The determination of whether an LOI is legally binding hinges on its phrasing and the shared expectations of those involved. Legally, this is typically evaluated by examining what both parties could reasonably anticipate from each other given the specific context of their negotiations.

In practice, the LOI is frequently a mixed document. Provisions regarding secrecy, the right of exclusivity, and the distribution of costs are commonly binding from the outset. Conversely, the core purchase terms are usually non-binding until the final agreement is officially executed. You should consistently include the phrase 'subject to contract' to confirm that you are not fully committed to the deal until the definitive legal documentation is signed.

Confidentiality and exclusivity: protect yourself before due diligence

Once a buyer obtains access to your company’s internal records, they gain visibility into proprietary data like profit margins, client lists, and strategic business plans. A robust non-disclosure agreement (NDA) is vital to stop sensitive data from being misused.

Furthermore, as a seller, you must ensure the buyer is not leveraging your internal information to gain an advantage while simultaneously negotiating with your rivals. An exclusivity provision requires the seller to refrain from engaging with other potential buyers for a defined period. Omitting these safeguards exposes you to unnecessary professional risks during the investigative phase.

Due diligence: what to investigate before and during the LOI phase

Due diligence represents the core of any acquisition. During this phase, the purchaser reviews the company’s financial, legal, fiscal, and operational records to identify potential risks.

Your LOI should specify how the data room will be accessed and the parameters of this inquiry. Consider the timeline and the involvement of professional consultants carefully. Remember that findings from this audit can drastically shift the final deal structure or valuation, making it a critical verification step.

Price, earn-out, and structure: agreements that bite later

Define an indicative valuation and the preferred structure—such as an asset or share purchase—within your LOI. Exercise caution; ambiguous terms often trigger disputes once the audit phase reveals new information.

Think about utilizing an 'earn-out' model, where the payout is tied to future performance, or choose between 'locked-box' or 'completion-accounts' pricing strategies. Also, remember to address matters concerning employee rights and pension commitments, as these are frequently the most contentious issues in a deal.

Conditions and conditions precedent

It is prudent to ensure the transaction is contingent upon 'conditions precedent'. These are specific milestones that must be reached, such as receiving favorable audit results, securing necessary funding, or obtaining regulatory clearance.

You may also need to secure formal approval from shareholders, lessors, or key vendors. Including these contingencies in your LOI guarantees that you are not trapped in a deal if the necessary requirements for success are not satisfied.

Costs, break-fee, and what if the deal falls through?

Negotiations are time-intensive and carry significant overhead in consultant fees. Consequently, you should establish clear terms regarding how costs are divided if the transaction terminates unexpectedly.

In some situations, a 'break-fee' is appropriate. This is a payment triggered if one party exits the negotiations without a legitimate reason. This mechanism reinforces commitment and provides a degree of financial recourse should the transaction fail to reach completion.

Key points at a glance

• Explicitly define which clauses are binding and confirm that the final deal only exists upon the execution of a formal contract.

• Secure confidentiality (NDA) and exclusivity agreements before disclosing sensitive business information or starting the audit.

• Clearly outline the timeframe, scope, and access protocols for the due diligence process.

• Document the price estimate and deal structure while maintaining flexibility for adjustments based on investigation findings.

• Explicitly detail earn-out arrangements, pricing methods (locked-box/completion-accounts), and plans for staff and pensions.

• Include essential conditions precedent, such as financing, anti-trust approval, and third-party consents.

• Agree on cost-sharing arrangements and a potential break-fee to manage the risk of a deal collapse.

• Specify the governing law, legal jurisdiction, and language that will apply to the final agreement.

• Retain a corporate legal advisor early in the process, well before the final documents are prepared.

What should you do now?

If you are involved in a business acquisition and are presented with a letter of intent, do not rush the signing process. Seek legal guidance immediately to safeguard your interests, prevent creating unintended binding obligations, and maintain the flexibility needed for successful negotiations.