Buying another business is one way you can enter new markets, acquire needed technology, subsume a competitor, integrate vertically or simply expand. A proposed transaction is often initially outlined in a letter of intent. This document broadly outlines the terms agreed on during preliminary negotiations and protects the deal during the last phases: due diligence, formal purchase offer and final negotiations. A letter of intent typically contains a transaction’s essential terms. Don’t be tempted to compose it hastily or take it less seriously than other documents, such as the formal offer or the sale contract. A properly written letter of intent not only protects your deal, but also helps you establish a strong bargaining position for final negotiations. But it isn’t a contract and doesn’t contractually bind the parties.
Take preliminary acquisition steps. After you decide that buying a business fits into your long-term strategy, the next steps include evaluating potential candidates, meeting with prospective sellers and narrowing the field to a primary candidate. At that point you’ll research the company and its leaders, estimate the company’s value, and- if it still looks promising – hold preliminary negotiations to discuss key purchase terms.
The most important terms include:
- The buyout price or a narrow price range,
- Deal structure – for example, stock vs. asset sale and payment terms,
- Whether the seller will continue to participate in the business – as either an employee or a consultant – or will be required to sign a noncompete covenant,
- List of assets and inventory to be transferred,
- Who will be responsible for liabilities – including taxes,
- Conditions or contingencies each party must meet before closing, and
- Assurances that the seller will make company records available to you on a confidential basis during the due-diligence phase.
- And you’ll want to be sure that those records support the seller’s representations about the company.
Write a letter
After you and the seller broadly agree on these and other important terms, compose your letter of intent.
Ask your attorney to help you write it – or at least review it before you and the seller sign it. This is especially important because you have to ensure that the letter of intent is not binding. In addition to summarizing the key agreed-on terms, the letter of intent may restrict the seller from entertaining offers from other prospective buyers for a specified period. In this respect, the letter
protects the preliminary agreement while you invest considerable time and professional fees in a thorough evaluation of the company’s operations, books, assets, contracts, pending litigation, insurance coverage, key employees, suppliers and perhaps customers. Sellers unwilling to be restricted from dealing with other potential buyers (essentially taking the company off the market while you conduct due diligence) should at least give you the right of first refusal in case another buyer makes an offer. Another alternative is that, in exchange for taking the company off the market for a specific period, the seller will be entitled to a partly nonrefundable deposit in escrow.
Include other provisions
Because every case is different, a standard letter of intent doesn’t exist. But here are some provisions that you may want to include in yours:
Introduction. Although the offer to buy and the final purchase agreement should be more formal, your letter of intent can be cordial. You can say, for example, “The purpose of this letter is to confirm our intention to acquire your company, XYZ Corp., according to the general terms and contingencies that we have agreed upon, summarized below.” Nondisclosure. If you haven’t already signed a confidentiality or nondisclosure agreement, the seller may insist that you do so now, before you peer into the company’s tax returns, payroll, contracts and other sensitive records.
Financing. You may want to reserve the right to obtain part of the purchase price from outside financing sources, using the target company’s assets as collateral.
Due diligence. State that your offer to buy depends on a complete and satisfactory review of such things as the company’s books, records and operations – to be conducted at your expense, completed within a specified number of days and subject to your (and some named advisors’) personal review.
Lease assignations. The seller will assign existing leases or transfer some lines of credit (or both) to the seller.
Continued operation. Until the sale is final, the seller will continue to operate the business as usual, meet all financial obligations, and maintain cash balances and net worth within a specified percentage of current levels.
Notification of changes. The seller will notify the buyer of any material changes in the company’s financial and operating condition.
Binding or nonbinding. State whether the letter of intent – or any individual terms or provisions in it- are binding. If not, you should say, for example, “These terms will be binding only on the execution of a final purchase agreement.” Most litigation in this area results from ambiguities as to what parts are binding.
Termination. State under what conditions either party may withdraw from negotiations.
Dispute resolution. Describe how disputes arising from the letter of intent should be resolved – for example, by mediation or under the laws of what state.
Keep in mind that you don’t necessarily want to include every term and contingency that will appear in the formal offer. You might want to leave some negotiating room. But you do want to remove doubts about issues that could lead to disputes.
Begin final stages
After you and the seller sign the letter of intent, the final acquisition stages begin: due diligence, formal offer, final negotiations, signing the purchase agreement and closing. We urge you to let us review your letter of intent, and other key documents related to an acquisition, before you sign them.