Using a Letter of Intent When Purchasing a Business
What is a Letter of Intent?
In its final form, a letter of intent typically sets forth the primary terms agreed upon between a buyer and seller in anticipation of a sale of a business or a large asset purchase. The parties may wish to make the letter of intent contractually binding and set out detailed terms which will be incorporated into the final purchase agreement. Or, the letter of intent may be a more informal agreement, providing for only the most material terms to the transaction, with the remaining terms to be determined at a later date. In either case, it can be an important tool, benefiting both buyers and sellers. So, what are the benefits of using a letter of intent when purchasing a business? This article explores that question and provides practical tips for both buyers and sellers in the context of a private sale.
Reasons Parties May Wish to Use a Letter of Intent
- Conserve Time and Money: This is a chief reason most buyers and sellers utilize a letter of intent. Before pursuing due diligence, which typically requires the expenditure of significant resources, the parties can identify the primary terms they are willing to accept and, if agreement can be reached on those main terms, it is less likely either of them will be wasting their time pursuing the transaction to closing. Deal-breaking terms can be identified early in the process, before substantial resources must be utilized.
- Facilitate Due Diligence: The letter of intent can be used to set forth a time frame and road map for due diligence to proceed, preventing surprises and the possibility of disputes down the road. For example, while a buyer may assume that the seller will turn over its financial records and tax returns during the due diligence period, some sellers resist full disclosure. Without an agreement on these terms early on, the process may be delayed while the parties negotiate which disclosures will be made. Spelling out the parties’ expectations and obligations regarding disclosure (and warranties) in a letter of intent can prevent additional costs or even a deal falling apart late in the process. It is also common for the letter of intent to provide a time period during which the buyer may terminate the transaction altogether, if their due diligence reveals unsatisfactory results or for other reasons. This can serve to motivate the seller to cooperate more fully in the due diligence process, or face termination of the transaction.
- Prevent Competition: Since the buyer will be expending substantial resources to proceed with due diligence, which may include hiring accountants, attorneys, and other professionals to assess the strength and viability of the business, it will want to ensure the seller is not negotiating with other potential buyers as the transaction proceeds to closing. A no-shop provision in a letter of intent can prevent the seller from engaging in other negotiations. A letter of intent may also include a provision requiring the seller to execute a non-solicitation or non-compete agreement with the buyer, which helps prevent the value of the business from being diluted due to any future activity by the seller.
- Maintain Confidentiality: For many reasons, most buyers and sellers wish to maintain the confidentiality of the sales transaction, along with any disclosures that are made throughout the process. A seller will usually be required to provide access to the buyers sensitive materials, including: trade secrets, confidential financial and employee-related information, internal communications, and a host of other highly sensitive materials. On the other hand, a buyer may not wish to make it known that they are contemplating the purchase of a particular business. A letter of intent can include binding language preventing either party from disclosing the terms of the transaction, as well as any disclosures made during the sale process, and require both parties to return materials to the disclosing party should the transaction terminate prior to closing. Or, it may require that the parties into a separate non-disclosure agreement. In either case, the confidentiality provisions can, and typically should, survive the closing or termination of the transaction.
- Further Negotiations Become More Focused: When a solid letter of intent has been drafted and executed by the parties, it generally provides a foundation for further negotiations, highlighting terms which remain outstanding. This makes for a more efficient use of time in proceeding with the transaction, which will require a final purchase agreement between the parties following the due diligence period. A letter of intent provides a head-start on the final transaction, often making the entire process more effective, less costly, and less likely to fail. From a seller’s perspective, their greatest leverage is typically before a letter of intent has been signed, so a more detailed letter of intent with terms favorable to the seller, can ensure a better deal at closing.
- Remedies: Like any contract, a letter of intent may include specific remedies which will be available to the parties should either party breach the terms agreed to in the letter of intent. Such language provides assurances to both parties that the agreed rights and obligations will be honored, again preventing an unnecessary waste of time and resources. On the other hand, a letter of intent may include language indicating that the parties do not wish to be contractually bound to the terms agreed to, but instead, the document is for the purpose of setting out what the parties intend to agree to (an agreement to agree, which is not generally enforceable in a court of law). This type of agreement to agree language is not typically recommended by our commercial law attorneys unless there are variables making it impossible to enter into a binding agreement at present.
A letter of intent may be just a few pages long or, with larger or more complex transactions, it may be a dozen or more pages long. Which terms are agreed to upfront in a letter of intent will often depend on factors such as the anticipated price of the sale, the type of industry involved, the sophistication of the parties involved, whether the parties are related or have an existing business relationship, and a variety of other factors. As a rule of thumb, our commercial attorneys recommend having more detail in a letter of intent, rather than less. This principle generally leads to smoother transactions and prevents waste.
If you have questions about the purchase of a business or business assets, call our experienced commercial and business law lawyers for a complementary evaluation at (858) 964-2314, toll free at (877) 333-2420 or send us an e-mail inquiry here.