Clients who are looking to buy or sell a business often ask, “Do I need a letter of intent?” The short answer to this question is “no.” However, the response would change to a resounding “yes” if the question were to be rephrased as “Should I have a letter of intent?”.
While letters of intent (also referred to as memorandums of understanding) are typically not intended to be binding contracts between potential buyers and sellers, they do memorialize the basic understanding between or among the parties, as well as the intention of the parties to commit to the transaction if the specificities can be negotiated and agreed upon within a set time frame. In a nutshell, a letter of intent is a commitment by the parties involved to use their best efforts to negotiate and consummate a purchase and sale transaction.
With a signed letter of intent in place, there is a physical document that can be referred to and referenced by all parties involved. It sets forth a framework of those specific terms that the parties have already agreed upon and that have been tied down, while also laying out those areas that the parties will need to come to mutually acceptable terms on before the transaction is completed. Those terms that have been agreed to by the parties and that are included within the letter of intent are usually some of the major points of the deal, which serves to streamline the balance of the negotiation process.
Letters of intent are valuable and constructive to have in place for additional reasons as well:
- they can serve to reassure a buyer or a seller who may think that the other party is not committed to following through with the transaction;
- they impose a duty of confidentiality upon the parties; specifically, all information about the deal itself and all confidential information that is exchanged between the parties from the time the initial discussions between the parties began, up until the time the transaction closes, or in certain instances, falls through, must remain confidential;
- they provide the parties with an exclusivity period, allowing them to negotiate the deal under the premise that the seller will not look for other buyers and the buyer will not look for other sellers during the exclusivity period (often referred to as a “no-shop” provision), effectively reiterating the intent of the parties to negotiate the deal in good faith; and
- they provide the parties with self-imposed deadlines to keep the deal moving forward with a target date for closing (or stopping the negotiation process)in plain sight.
Initially, a client may be hesitant to have a letter of intent based on financial concerns (as it can be viewed as an added unnecessary expense) or a belief that it will be a time drain (as certain points encompassed within the letter of intent itself must be negotiated). However, after their deal has closed (and even in those instances when their deal may have fallen through) the majority have expressed to us that spending the time and money up front on drafting and signing off on the letter of intent was time and money well spent.