Revised and updated May. 16, 2020
In acquisitions of privately held companies, a letter of intent/term sheet is often entered into by both parties. The purpose of the letter of intent is to ensure there is a “meeting of the minds” on price and key terms before the parties expend significant resources and legal fees in pursuing an acquisition, and before sellers agree to grant exclusivity to buyers.
The purpose of this article is to explore the key issues in negotiating and drafting an acquisition letter of intent.
What Is Typically Included in a Letter of Intent?
A letter of intent can be short or long, depending on the dynamics of the negotiations and the desires of the parties. Here are the types of items that can be included in a letter of intent, a number of which are discussed in greater detail later in this article:
- Price/Consideration—Will it be all cash, all or part stock, earnout, or promissory note?
- Adjustments to the purchase price—Will it be a cash-free/debt-free deal? A working capital target at closing and adjustment mechanism? Treatment of severance costs and transaction fees and expenses?
- Transaction structure—Will it be an asset purchase, purchase of all outstanding shares, or a merger?
- Expected timeline for due diligence and negotiating the deal
- Any escrow to secure the seller’s indemnification obligations, how long the escrow will last, and for what items the escrow will be the buyer’s sole remedy for claims
- Whether M&A representations and warranties insurance will be used in lieu of an escrow and who pays for the policy
- Exclusivity for the prospective buyer—How long will exclusivity last? When can the seller terminate exclusivity early?
- Access to the employees, books, and records of the seller for the benefit of the buyer as part of its due diligence process
- Scope of key representations and warranties of the seller (will some key reps be subject to qualification by a “materiality” or “knowledge” standard?) and survival period
- Incentive arrangements post-closing for employees
- How seller employee options and equity held by employees will be treated (will they be assumed by the buyer or terminated?) and whether these are in addition to the purchase price
- Activities prohibited by the seller pending closing
- Whether any third-party consents to seller’s key contracts will be required or sought, as a consequence of the acquisition
- The confidentiality obligations of the parties concerning the transaction (and ideally a non-disclosure agreement will already be in place by the parties)
- How seller’s employees will be hired/treated by the buyer
- Continuing indemnification obligations of the buyer for seller’s officers, directors, employees, and stockholders, pursuant to any existing Indemnification Agreements or charter provisions
- Conditions to closing the transaction, both for buyer and seller
- Whether any non-compete/non-solicit agreements will be required
- Indemnification obligations by the selling stockholders and the limits and exclusions from such indemnification provisions
- How and when the acquisition agreement can be terminated
- How disputes will be handled and in what jurisdiction
Short-Form vs. Long-Form Letter of Intent
Long-form letters of intent are more comprehensive and legally constructed, and designed to reach a meeting of the minds on many of the key terms of a potential deal. The key advantages of a long-form letter of intent are:
- Issues that can be deal breakers are identified early on and resolved, before spending significant legal fees and management resources for both the buyer and seller.
- Resolution of significant issues early on can make the process of reaching a definitive acquisition agreement easier and more efficient, with resulting savings in time and legal fees.
- If an important issue surfaces as insurmountable, for sellers it is better to learn that early, rather than learn about it when the seller is in exclusivity and a termination of discussions at that point could be more damaging or difficult for the seller.
The primary disadvantage of a long-form letter of intent is that it may bog down the momentum of getting a deal done, as the parties deal with too many difficult issues early on. It may also result in the breakdown of the negotiations that could have been avoided if certain issues had been deferred.
Published at Wed, 20 May 2020 12:00:00 +0000