Do You Really Need a Letter of Intent?

Business Insights

Do You Really Need a Letter of Intent?

Sep 18, 2019 | Business Insights

Letter of Intent, Term Sheet, Indication of Interest, and LOI – what do these all mean? These are actually different terms for fundamentally the same thing: a document that describes the terms of a future transaction. Each has a different style and has specific terms about the proposed transaction, and each can be helpful to document the future transaction.

A Letter of Intent, or “LOI”, is a classic agreement between a buyer and a seller regarding a purchase. Typically done early in the deal negotiations, it’s a basic understanding of a transaction to be used in the preparation of the deal documentation.

Usually styled as a letter from the Buyer to the Seller and signed by both parties, the LOI contains certain non-binding deal terms: purchase price (which can be a formula), method of payment (cash, note, equity in Buyer or combination thereof), timing, diligence to be conducted, and ancillary terms to the deal (future employment, non-compete or exclusivity).

Following a signed LOI, the Buyer typically then proceeds to the due diligence review of the Seller – which can be very costly for the Buyer and very exposing for the Seller. Without the understanding on the basic deal terms the LOI provides, the Buyer may not want to take on that time and expense, and the Seller may not want the risk of providing their financials and other confidential information available to a Buyer. The LOI gives both parties reassurances that a deal is more likely than not.

The deal terms listed in the LOI are non-binding because the parties want some flexibility in the transaction before diligence is completed. For example, the Buyer may find additional liability that would reduce the sale price, or may realize that the financing they thought they could obtain is not actually available.

Outside of the deal terms, there are a handful of terms in the LOI that are usually binding on the parties, like confidentiality, exclusivity with the Buyer (if negotiated), and the obligation to operate the business in the ordinary course prior to the transaction date.

Used even earlier in the negotiation of a deal than an LOI, an Indication of Interest, or IOI, has even fewer deal terms. IOIs are typically styled as a letter solely from the Buyer and provide a very general indication of the Buyer’s intent to enter into a deal.

They may include only a vague range of purchase prices, but get the Buyer “in the door” to receive information on the Seller, including a Confidential Information Memorandum or “CIM”. While not always used, an IOI is sometimes requested just to narrow the number of potential buyers in a deal.

Alternatively, an unsolicited Buyer may send one to an identified target. The Board of Directors at the target may have an obligation to investigate the possibility of selling the Company to the Buyer, which could set off an auction process to find a high price for the shareholders.

Term Sheets are very similar to LOIs in terms of timing and the specificity of deal terms, but often times look very different – and sometimes could simply be a bulleted list, signed by the parties or not. Term sheets are seen in transactions involving the purchase of an entire company, but you can also see them in other types of transactions, including stock issuances, loan financings, and severance/release agreements.

Any document that adequately describes the intent of the parties can be helpful to propel the transaction forward. These documents enable the parties to understand what they are getting into and to assess risks and rewards, before they spend time and money drafting the definitive agreements.

This article is for informational purposes only and does not contain or convey legal advice. Consult a lawyer. Any views or opinions expressed herein are those of the authors, and are not necessarily the views of any client.


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