Jackson Ross PLLC

The Important Role that Letters of Intent Play in Business Transactions

When parties engage in business with one another, it is important that each party makes its intentions and expectations clear to the other party.  Transparency at the outset of a transaction, and then throughout the transaction, helps to ensure that both parties are on the same page.  When it comes to mergers, acquisitions, and alliances, making each company’s intentions known is key to prevent a deal from falling apart at the outset.

The letter of intent is one of the first documents used by a business to suggest a non-hostile business transaction, such as a merger or acquisition.  By indicating a party’s interest in a M&A transaction and laying out the proposed deal terms, a letter of intent serves as a jumping-off point for future negotiations.  While letters of intent are generally not binding legal documents, they may contain some provisions parties will be required to observe.  The content of the letter also carries a certain amount of moral weight, for it is generally considered bad faith to push too hard for more favorable terms that what was in the letter of intent.

What Kinds of Terms Should be Included in a Letter of Intent?

A letter of intent is almost like an initial offer, and as such there are certain key terms that a letter of intent should include.  These initial terms are used to shape the scope of the transaction and are meant to address some key points that are relevant to the transaction.   Some of these terms may seem intuitive, while others less so.  Providing these terms in a written letter of intent helps the communication and mutual understanding between the parties and services to speed up negotiations.

  • Specify the transaction. What is your intention?  Is your intention to buy, sell, or merge with the target company?  Your letter of intent should specify your proposed transaction and should make clear each party’s role.
  • Price and structure of the transaction. Price is one of the most important aspects of a letter of intent.  Each party needs to know how much the deal will cost.  It is also important to specify how payment for the transaction will be structured—for instance, whether the deal would be a cash deal, a stock transaction, or some combination thereof.  This will inevitably change throughout the course of the negotiation, but it is good to have a starting point set down in writing.  In re price, we generally advise providing a range and then stating the exact price will be subject to further due diligence.
  • Proposed time frame. In certain transactions, timing may “be of the essence”.  Including a proposed time frame for the deal in the letter of intent, such as a closing date, can be helpful in moving the transaction and negotiations forward.  It also helps the parties understand each other’s expectations for the deal.  In transactions where timing is not critical, the parties can agree to decide on a time frame later in the negotiation process.
    • In some transactions, a time frame might be imposed on the transaction due to regulatory requirements.  For transactions conducted in regulated industries, it is important that the letter of intent include a proposed time frame that addresses any regulatory compliance timing issues.
  • Whether there are any binding terms. In some transactions, there might be terms in a letter of intent by which the parties agree to be bound.  Exclusivity clauses are a common type of binding term that is found in a letter of intent.  An exclusivity clause is used to safeguard the deal during the negotiation stage, before a formal agreement is reached, and prevents each party from entertaining other potential deals until some final decision is made concerning the present transaction (e.g., the deal goes through or is terminated).
  • Statement that the letter of intent is not binding. Generally speaking, letters of intent are non-binding, and should include a term that expressly states such, save for any expressly binding terms, such as an exclusivity term.  It is important to clarify that the letter of intent is neither a formal agreement nor a binding contract unless specifically provided otherwise.
  • Contingencies. In certain transactions, the entire transaction might depend on a certain contingency.  For example, a sale might be contingent upon the buyer obtaining specific financing or the buyer might require that the sale is contingent upon certain employees or talent being acquired through the transaction (so the deal would fall through if the talent left before the transaction closed).  Alternatively, the deal might hinge on the target company receiving a valuation above a minimum threshold.  If the deal is contingent upon certain closing conditions, the letter of intent should make clear what these contingent circumstances are so that later there is no doubt the parties were fully aware of them during the negotiations.

Business transactions can be complex, so taking steps to make your intentions clear and known by the other party helps to facilitate a successful transaction.  The parties should have a mutual understanding of each side’s goals and objectives, as having such knowledge makes for more effective negotiations.  Being as transparent and direct as possible early on, while requiring mutual trust and careful planning, can help save a lot of time and money in the long run by avoiding confusion and misunderstanding.