A letter of intent (LOI) is far more than a legal document. It’s a key milestone in the M&A process and can be a powerful tool for getting the deal done. The LOI outlines the basic parameters for an acquisition including the period of exclusivity, purchase price and consideration, preferred deal structure, and expiration date. It is important that the LOI is strategically drafted. Several deals have gone awry due to critical mistakes made in the LOI.
Here is a list of 3 items that you as a buyer should not include in an LOI.
Item No. 1 – Binding closing obligations
Most LOIs are non-binding, it means that there are no penalties for either party if the deal does not go through. A signed LOI marks the beginning of formal due diligence, when you get access to confidential information. It is not a good idea to legally commit to the acquisition, before you get all the information. During the process of due diligence, you may come across information that makes you want to alter certain provisions in the LOI.
Item No. 2 – Breakup fees
A buyer should never be monetarily responsible for walking away from a deal. If during the due diligence process, you uncover information that significantly impacts the deal – you want to have the flexibility to walk away. Breakup fees are common in large publicly traded transactions which are subject to regulatory scrutiny.
Item No. 3 – Making a good faith payment (Earnest Money)
Buyers sometimes make a good faith payment to the seller to demonstrate their commitment to executing the deal. However, a signed LOI is an excellent way to indicate continued interest and commitment to a seller. The LOI does not legally require the seller to sell their company. Wait until the definitive purchase agreement is signed.
When drafting the LOI, it is best to avoid binding provisions, breakup fees, and earnest money deposits so you can build maximum flexibility for due diligence findings and negotiations.
Bonus Tip – When you draft the LOI, consider the big picture and your desired relationship with the owner.
