When buying a business or some of its assets, the process can take a while before the parties to the transaction reach an agreement and close on the deal. Normally, the process may have started with a verbal declaration of interest from several parties. A Letter of Intent is a document issued by a buyer to a seller to formally start the negotiations of the buying process. It is mostly used in the sale of a business/mergers and acquisitions. It indicates serious interest in getting the transaction going. Check out this 2-minute overview of this document by The Harrison Law Group.
Purpose of a Letter of Intent
- A Letter of Intent drafts out the fundamentals of the transaction and other general terms that form the basis of negotiations.
- Other interested parties to the transaction, for example, investors or shareholders, might need proof that negotiations to an agreement are ongoing. In such an event, a Letter of Intent can be used as evidence.
- A Letter of Intent is also indicative of a mutual dedication to get to an agreement and close on the transaction.
- A Letter of Intent sifts through committed buyers so that less time and energy is wasted carrying out such things as due diligence or preparing a contract to buyers who are not interested beyond a verbal show of interest.
- Through the Letter of Intent, buyers and sellers are able to agree on important terms such as payment, timelines, post-closing obligations, etc. thoroughly before concluding on the deal.
- A Letter of Intent clearly outlines the responsibilities expected from each party, thereby making the negotiations and closing process fast and efficient.
- In some cases, a Letter of Intent (If the terms therein clearly state so) can give the buyer power to hold on the property even when they have not closed on the transaction. This means that the seller cannot sell the business to any other interested party. This privilege to the buyer is known as the Right of First Refusal.
With all these benefits to having a letter of intent, could there be any doubts as to whether this document is necessary? Wouldn't it be easier to offer a price straight up and put money down thus doing away with this document altogether? Attorney Brett Cenkus takes us through a 5-minute walk through of the merger and acquisition process to show specific scenarios where a letter of intent becomes needed.
Beyond mergers and acquisitions, letters of intent still prove valuable in large scale property acquisitions, particularly in real estate where deals can take time to come through.
How to Write a Letter of Intent
A letter of intent is divided into several sections based on the message you want to convey to the seller. What is important is that with the letter, you are able to connect and reassure the seller than you are serious about making a purchase and that he or she only needs to work out finer details in the deal before you close.
This section first clearly identifies in writing that the document is a Letter of Intent. It also outlines who the parties to the transaction will be by their full names and their role in the transaction (buyer, seller, etc.). The parties can then have a generic identifier, e.g., Party X, which will then be used in the rest of the document.
In this section, the property/asset that is the subject of the transaction is detailed. It should be clear enough to erase any possible doubts. There should also follow an outline of the roles and responsibilities expected from each party to the intended transaction.
In every transaction, there is something promised or issued in exchange for another. This section, therefore, outlines the form of exchange expected. For example, consideration could be in the form of money. The amount, mode of payment, and expected date of payment should all be included here. It should also be noted if the payment will be made all at once, in installments, in advance or if credit is acceptable. Other forms of possible consideration are shares, exchange with other forms of property, etc.
Setting a closing date defines the validity of the Letter of Intent. This section should also state what happens when the date arrives, and an agreement has not been met. Possible outcomes can be; all obligations are lifted, and agreements are withdrawn or a time extension is offered. This part also outlines how withdrawal before the closing date should be carried out. For example, by writing a letter and bringing it to the attention of the other party within a specified time.
This part lists down the things that must be done to get the negotiations going towards reaching an agreement. For example, all parties must sign the Letter of Intent to kickstart negotiations, and all applicable licenses/ permits/ resolutions giving permission to the transaction must be gathered.
This refers to a comprehensive and thorough evaluation to ascertain the facts or potential of the transaction in hand. In the case of a sale of a business, the buyer will carry out due diligence to find out if the transaction has commercial potential. The seller might also want to evaluate the creditworthiness of the buyer.
In the sale of real estate, particularly in transactions where structures are pre-sold, due diligence may involve inspecting a model unit to ascertain that the finished structure will fit the needs of the buyer.
This section can contain a clause stating that the parties are free to move on or leave the negotiations depending on their due diligence results but only after notifying each other. It can further state that silence to communicate on the completion of due diligence after a specified time translates to a withdrawal.
In some cases, an information accessibility clause is included. This clause is important to include so that each party to the transaction is allowed to get any information they may require about each other.
Non-disclosure and Non-compete
A non-disclosure agreement is important to include in a Letter of Intent to avoid either party from divulging any important information gathered about the other, especially during due diligence or during the negotiations.
Non-compete means that either party cannot use any information gathered to compete against the other party. This section can even go further and include a non-solicitation clause, which means that either party cannot poach any stakeholders of the other party’s business, e.g. customers, employees, etc.
In most cases, this section is binding. Any party contravening what has been agreed upon, whether the negotiations fall through or not, can be found liable in a court of law.
This section outlines on who is to cater for any expenses incurred when carrying out the negotiations, whether they are successful and close or even with the eventuality of a withdrawal. In most cases, each party bears its own costs.
Generally, in itself, a Letter of Intent is not binding. However, there are specific clauses that are binding. It is important to state that in this section. That apart from the highlighted binding segments, the rest of the content in the document is not binding.
Final Agreement and Signatures
This section states that If specific and unique negotiations items are agreed upon, all other general terms and outline of a contract agreement will be followed. This makes it very easy and fast to draft the final contract. When the parties sign they show that they are amenable to the content of the Letter of Intent. There should also be a date when the letter is signed.
Who prepares a Letter of Intent?
In the case of a sale of a business, buyers prepare a Letter of Intent. They can do that by themselves since it is a simple document. This is possible through the help of online resources such as this guide. They can also consult an attorney to assist them to draft one if they are not too sure about what to include.
In the case of making offers for real property that is on sale, you can do this yourself. In addition to writing out the sections detailed above, you can optimize your letter of intent to purchase by following some of the tips detailed in this short video guide by Peter Harris of Commercial Property Advisors.
Is a Letter of Intent binding?
A letter of Intent is generally not binding. This is because it just outlines proposed intentions to negotiate for an agreement. However, there are clauses included in the letter that are binding by themselves. For example, a non-disclosure, non compete, and non-solicitation provisions are binding.
One should also be keen on the general language used in the letter so that the wordings do not imply anything binding when it was not meant to.
Letters of Intent vs. Other Similar Documents
A letter of intent is very similar to other documents which precede completed agreements. These documents include memoranda of agreement, term sheets and offer letters. However, they have salient differences depending on your location. In some cases such as with offer letters, the two documents are different altogether.
Letter of Intent vs. Memorandum of Agreement
A Memorandum of Agreement, just like a Letter of Intent, outlines specific points of agreement desired to be carried out to completion and lead to a contract. It describes the property/issue at hand, the parties involved, their expected responsibilities, etc. US law considers a Letter of Intent, Memorandum of Agreement, and Memorandum of Understanding to be almost one and the same thing.
Letter of Intent vs. Term sheet
A Term sheet, just like a Letter of Intent, is used in large transactions to convey interest by indicating how the price and general structure of the intended transaction will be if agreed upon.
The difference lies in the technical outline. While a Term sheet will mostly focus on pricing, a Letter of Intent gets into details. Center Electric Co-Founder and Opsmatic CEO Jay Adelson, defines a term sheet as a series of terms that you feel wil be material to a transaction. As such, a Term sheet will more often than not have the format of a list with key bullet points. Check out his short overview of how to construct an effective term sheet.
In contrast, a Letter of Intent takes the format of a letter or general document with “clauses.” It is also common to have a Term sheet precede a Letter of Intent. In this case, the term sheet could be like three pages. If agreed upon, then a Letter of Intent is issued to give room to other details of the agreement, such as due diligence.
Letter of Intent vs. Offer letter
Sometimes people may confuse a Letter of Intent and an Offer Letter. This is because outside of business, a Letter of Intent can be used when applying for such things as grants, jobs, college applications, etc. It then follows when such an application is successful, the receiving organization will send an Offer Letter to the applicant.
It is good practice to keep a Letter of Intent short with simple and general terms. If it is too detailed, it may end up having binding clauses. This may not always be a good idea. When drafting a Letter of Intent, if you are not sure about what to include, you can consult an attorney or rely on online resources for assistance.
Since the person who first drafts a Letter of Intent is the one who has the upper hand in determining what issues will be addressed, it is important for the receiving party to be keen on the terms laid out before signing. There can be as many as three revisions before signing on the Letter of Intent.
Because a Letter of Intent is generally not binding, it implies that either party can withdraw from the agreement (in writing) and bring it to the attention of the other party. However, this has to happen before the agreed closing date or as guided by the Letter of Intent.