Letters of Intent: How to Avoid Added Cost and Headaches in Buying or Selling a Business
By Kyle D. Winey, Esq. and Robert Showers, Esq.
Imagine you want to buy or sell a business. Excitement is high and patience is low. That’s why you want to execute something quickly. After all, you don’t want to let this deal slip away. As a result, you call an attorney to draft an agreement. “We already agreed to everything,” you say to the attorney. “All you have to do is draft the agreement.”
In this approach, the client often believes that the parties agreed to 95% of all relevant terms. The lawyer simply needs to round out the remaining 5% of agreement with “legalese” and not screw up the 95% of the terms to which the parties agreed. Time is of the essence, the client believes, and the lawyer simply needs to play the role of the scribe.
WE see this approach all the time, and it usually spells disaster for the client.
In this scenario, the likely outcome is—at a minimum—increased attorneys’ fees for the client. Why? Because the parties have rarely even discussed critical terms to the agreement, what we call “big rock issues,” let alone actually agreeing to these terms. Upon lawyers introducing these big rocks for consideration, the reaction from the other party can range from anywhere to complete surprise to stonewalling. Indeed, if the back-and-forth is severe, it could undo the entire project.
Thus, jumping right into drafting and negotiating a 50-page purchase agreement is often a bad idea. Think about paying an attorney to draft a lengthy, complicated agreement to only later discover that the other side won’t agree to half of it. At that point, the entire agreement is scrapped and much money is wasted.
One of the easiest ways to prevent this problem is through a letter of intent (commonly called a “LOI”). A letter of intent establishes the core of an agreement before the parties spend a lot of time and money drafting an extensive agreement. Some of these core provisions of a letter of intent include:
- Price and Structure. Certainly, the total purchase price is critical. However, the payout of the purchase price is often overlooked but is equally critical. For example, is a lump-sum required at closing or can the purchaser pay off the total obligation over a certain time period?
- Employment Rights. Often when a sale occurs, there are employment implications. For example, is the seller permitted to remain an employee of the company? Is the seller permitted to work at other similar companies? What about non competes and non- solicitation provisions of the customers and employees that make the business so valuable?
- Assets to be purchased as part of the deal. Do the customer lists, all physical equipment, bank accounts, accounts receivable come with the deal?
- Liabilities. What happens to the debts and liabilities of the company? Is an indemnification provision required for any past acts or exposures or does the new buyer take all these past potential liabilities?
- Intellectual Property. Who gets the name, logo, trademarks and copyrighted materials and is it exclusive or non- exclusive rights?
- Expenses. There are often additional expenses associated with the sale of a company. Attorneys’ fees are part of those expenses, but often realtor fees, broker commissions, and other third parties facilitate the process. Clarifying who is paying for these expenses is vital.
By addressing most, if not all, of these concerns, a letter of intent minimizes the likelihood that a party may be surprised with a deal-ending position deep into the negotiation process after a greater expenditure of legal costs and personal time commitment.
In the drafting process, many letters of intent contain provisions that are binding. Common binding provisions include a “due diligence” provision (i.e. the time a party has to investigate the health and position of the company), a “no-shop” provisions (i.e. a party cannot continue to market the company during the due diligence process), and a “confidentiality” provision (i.e. a party cannot disclose the information he or she learns to third-parties as a result of the due diligence process).
Not all provisions, however, are binding. In fact, given that the negotiation process is still early when drafting a letter of intent, many parties prefer that most of the provisions are not binding. Many common non-binding provisions include the purchase price. After all, a buyer seldom wants to be bound to a certain price until the due diligence process is complete. Another typical non-binding provision is the structure of the transaction. Sometimes people prefer an “asset purchase” structure (i.e. only certain assets are purchased, but not the liabilities), while other deals are better structured as a “stock purchase” (i.e. the underlying equity of the company and associated all rights and liabilities). Parties rarely want to definitively agree to these terms, however, until the due diligence process is complete. Also, letters of intent usually have a good faith deposit, some of which becomes non-refundable after certain events or time frames, which helps move the process along by allowing both parties to count the costs.
By using a letter of intent to resolve these items early in negotiations, the completion of the final agreement is a much, much smoother process. People who try to tackle the final agreement without executing a letter of intent first often find themselves subject to added costs, more stress, and even a deal that blows up. Don’t let this happen to you. Take the time to set expectations and establish the parameters of a deal early by using a letter of intent.
If you seek guidance in drafting a letter of intent, or if you desire to speak personally with an attorney about your options, please contact attorneys Kyle Winey, Esq. or H. Robert Showers, Esq. of Simms Showers, LLP, located in Leesburg, Virginia at KDW@simmsshowerslaw.com or HRS@simmsshowerslaw.com or call 703.771.4671.
Disclaimer: This memorandum is provided for general information purposes only and is not a substitute for legal advice particular to your situation. No recipients of this memo should act or refrain from acting solely on the basis of this memorandum without seeking professional legal counsel. Simms Showers, LLP expressly disclaims all liability relating to actions taken or not taken based solely on the content of this memorandum. We greatly appreciate the contributions to this article by Daniel Thetford, Paralegal. Please contact Robert Showers at firstname.lastname@example.org or Kyle Winey at email@example.com for legal advice that will meet your specific needs.