4 KEY TERMS FOR EVERY LOI
Most purchase and sale agreements for the sale of a business begin with a Letter of Intent (“LOI”). A basic LOI contains material business terms (such as purchase price, the purchased asset(s), and the proposed closing date) to put in writing what has been previously discussed between the parties. However, there are key deal-structuring and legal terms that must be included for the LOI to be complete – and to ensure the parties are on the same page as they move forward to a definitive agreement.
Buyers and sellers may feel wary of including such terms for fear of scaring off the other party. For the sake of moving quickly past the LOI stage, the parties may decide to put off discussion of these important items to the definitive agreement stage. This decision may prove costly in the long run if the parties discover an unbridgeable gap after thousands of dollars have been spent on due diligence and drafting of the definitive agreements. Discussing these terms at the LOI stage, when the invested costs are negligible, will help identify how far apart the parties are and if the parties are willing to make a compromise to move the deal forward and ensure the parties are anchored in the same mindset. While working out these details at the LOI stage may lengthen the negotiation period, it will shorten the back and forth negotiations during the definitive agreement stage and increase the odds of a successful closing. Here are the 4 key terms:
Exclusivity Period and Expiration Date – An exclusivity period keeps the buyer and seller “exclusive” or locked-in to the deal, from the date the LOI is executed to a pre-determined end date, typically a length of time to draft and execute the definitive agreement. This term is beneficial to the buyer as it prohibits the seller “shopping around” the LOI terms. However, a savvy seller would agree to an exclusivity period to secure a qualified buyer, and use the exclusivity period to negotiate a favorable expiration date, i.e., the date when the LOI would expire and the seller would be free to entertain other offers. A skilled attorney can help analyze the nuance of a buyer or seller’s situation to determine the best balance between these two competing terms. While the terms of an LOI are generally non-binding, these terms would be binding on the parties.
Confidentiality – The LOI should contain a good confidentiality provision. This is to the benefit of both the buyer and the seller. Should the deal fall through, a buyer or seller would not want a third party to use the terms of the LOI against them in future negotiations. While most provisions of an LOI are non-binding, the confidentiality provision should be binding on the parties and survive the termination of the LOI.
Indemnification Terms – As one of the most crucial provisions in a purchase and sale agreement, indemnification clauses allow the parties to customize the amount of risk they are willing to take in the transaction. The threat of a lawsuit from a third party affected by the transaction is always a risk in any purchase and sale. It is best to work out the key details in advance regarding who will bear the liability, and thereby anchor the parties for smoother negotiations during the definitive agreements stage.
Indemnification terms to consider for the LOI are:
- Indemnification rights for direct claims and third party claims;
- The length of the indemnification survival period after closing;
- What representations, warranties and covenants will apply to the survival period, what will not apply, and what will last indefinitely;
- The amount of the indemnification basket (tipping or deductible) and cap, if applicable
Restrictive Covenants – If the buyer desires any type of restrictive covenant in the definitive agreement, it is in the best interest of both parties that these key covenants be listed in the LOI, rather than be brought up at the definitive agreement stage where the parties can find themselves at an impasse. Restrictive covenants include, but are not limited to: non-competition provisions, non-solicitation, confidentiality and non-disclosure, provisions regarding key employees.
Every buyer and seller needs a skilled attorney to help them walk through the complexities of every purchase and sale. With our extensive experience in M&A transactions, the attorneys at VRS can assist both buyers and sellers in negotiating the LOI tailored to our clients’ needs, as well as drafting and negotiating the definitive agreements, to set the parties up for a successful purchase and sale agreement and closing.