LOIs (Letters of Intent) are often viewed as perfunctory but aligning expectations for a transaction begins with the LOI. Buyers often want to get sellers “under the tent” as quickly as possible and sellers often will be willing to punt on issues in an effort to race to the finish; however, misunderstandings in a deal lead to bottlenecks, inefficiencies and, as the saying goes, time kills all deals. Fulsome LOIs cut down on the back and forth typical in transactions and can be a valuable tool for a buyer and seller in avoiding unnecessary deal fatigue. Although neither a buyer nor seller wants to incorporate every conceivable point in the LOI, there are materials points of contention common in most transactions but absent from LOIs. Below are some of the commonalities I’ve found in what I consider encompassing LOIs.
- Consideration. All LOIs have a section which deals with the consideration a buyer will pay. Typically, this section includes the enterprise value, up-front cash, value or amount of equity the seller is expected to retain or “roll over” into the ongoing venture, conditional consideration such as earn-outs or similar, holdbacks or escrowed dollars to account for net working capital and/or indemnity claims, seller notes and other similar items. Although all these items are typical, the devil is in the details. If either side plans to ask for uncommonly aggressive terms, it should that clear from the outset. In an earnout, the buyer should consider incorporating the definition of what metric it plans to measure in the LOI, especially in the case of EBITDA as methodologies for determining vary greatly. If material terms in applicable governing agreements materially change the nature of equity the seller will hold post-closing, it may be worth stating that from the outset. If a seller plans to ask for an uncommon mechanism for an escrow release, it should consider adding it to the LOI. A failure to include material terms which are atypical is easily avoidable and can save both sides the pain of protracted negotiations.
- Representations/Warranties/Survival. It’s best to clearly articulate what reps and warranties will be considered “fundamental” and to articulate time frame(s) those survive in the LOI itself. Leaving this open-ended with “customary” or similar descriptors without delving into specifics can cause prolonged negotiation post-signing. Similarly, incorporating relevant caps/baskets in the LOI can help the parties quickly move past what is often the most negotiated aspect of purchase agreements in transactions.
- Restrictive Covenants. Similar to representations and warranties, I’ve found it helpful to specifically delineate which documents will have restrictive covenants (including geography and territory) and the respective restrictions contained in each. It can be an issue for both sides if a seller expects to sign a five-year non-compete and later finds itself subject to a period which exceeds that in other agreements. If the buyer expects a seller to agree to covenants which vary in scope, it should consider including a brief summary in the LOI. I’ve found tables are a good way to illustrate restrictive covenants and are easy for both sides to understand.
- Conditions to Closing. If a buyer expects to take an aggressive stance on what conditions there are to closing, it should clearly articulate those in the LOI. For example, if the buyer plans to continue its diligence post-signing and the buyer wants to retain the option to terminate the agreement for a diligence issue (absent a break fee or similar), it should include in the LOI. There are any number of conditions a buyer may want to include outside of MAE (material adverse effect) conditions, reps and warranty bringdowns, discharge of indebtedness and similar conventional conditions.
- Employment. Often employment agreements can be one of the most negotiated documents in a transaction. I always encourage buyers and sellers alike to spend more time setting forth the material terms of post-closing employment (for both key employees and for owners) so as to avoid derailment later. In addition to a fulsome employment section, I encourage buyers (and advise sellers to ask for) a short summary of benefits which lives outside of the LOI but provides a snapshot of how a seller’s coverage stacks up against a buyer. Typically, this is requested later in the process, but sellers should be mindful of how their benefits stack up against a buyer’s as ultimately this will be a material factor for a seller’s employees. Another item parties should consider including is what the definition of “cause” will be in the LOI itself. Although there is no need to draft an employment agreement into the LOI, the definition of what constitutes “cause” can quickly become a gating item if a buyer takes an aggressive approach. If an owner is going to ask for severance in the event of a cessation or employment or a right to terminate his or her employment agreement with “good reason,” the parties should memorialize this in the LOI to avoid an impasse later as many buyers consider such provisions taboo.
- Real Estate. For transactions where the owner plans to lease a wholly owned facility back to a buyer, the parties should set forth the obligations they expect of each other in the LOI. Some buyers will agree to cover taxes and insurance but will balk at assuming the obligation to repair/replace/maintain. Similarly, sellers may take positions similar to a REIT (real estate investment trust) and try to push all obligations back to the buyer. In either case, being upfront with expectations can save both sides downstream headache.