The letter of intent is a central component of the mergers & acquisitions (M&A) process. It is a joint declaration of intent that is signed by the parties involved and guides the negotiations on a company purchase in an orderly manner. Although the LOI is usually not legally binding, it plays a decisive role in creating a solid basis for the further procedure, in particular the due diligence process. This article sheds light on the importance of an LOI and looks at the key content that should be included in such a document.
The LOI in the M&A process and differences to the NBO and term sheet
In a structured M&A process, the seller approaches various potential buyers, usually via a specialised M&A advisor. If there is interest, extensive documentation is made available, initial discussions are held between the parties and the most important questions of the potential buyer are answered. In some cases, limited access to a data room is granted.
On this basis, non-binding offers (NBOs or non-binding offers) are requested from the interested parties. An NBO is a unilateral expression of interest in which the buyer summarises the valuation and important assumptions of their offer. The seller can now form an impression of the offers and – depending on the competition – continue the process with a selection of interested parties.
Then a more in-depth (so-called confirmatory) due diligence begins: the buyer will begin an intensive examination of the company, typically with the involvement of external experts. However, a potential buyer will often require the conclusion of an LOI before going deeper into due diligence or contract negotiations. One important reason for this is that, depending on the size and complexity of the company, relatively high costs are incurred that the buyer wants to secure. In venture capital financing, the term ‘term sheet’ tends to be used in the process. There is no clear distinction between this and the LOI, but the term sheet is typically more concise and focusses more on commercial points and governance issues.
The LOI in the M&A process
Purpose and advantages of a letter of intent
The LOI primarily serves to outline the main features of a potential transaction and to create a common understanding between the parties involved. In some cases, the aforementioned non-binding offer is developed into a type of LOI and signed by both parties.
The most important functions of an LOI include
- Creating clarity: The LOI sets out the key points of the transaction, such as the purchase price, the structure of the deal (e.g. share deal or asset deal) and other key terms.
- Build trust: Signing an LOI demonstrates the parties’ commitment to pursue the transaction seriously and in good faith.
- Framework for due diligence: The LOI creates the basis for the detailed examination of the target company by defining the framework for gathering and analysing information.
- Avoid misunderstandings: A written elaboration of the most important topics reduces the risk of later discrepancies.
Key contents of an LOI in the sale of a company
A well-structured LOI comprises several key elements that take into account the interests of both parties. These are
1. Description of the transaction
This describes the subject matter of the proposed transaction. This includes information about:
- The target company or business unit to be sold.
- The proposed transaction structure (e.g. acquisition of shares or assets).
- The parties involved in the transaction.
2. Key financial data
The LOI sets out the purchase price and often contains information on the valuation basis. This is particularly important if the need for a purchase price adjustment arises as a result of due diligence. In addition, the consideration (cash payment, shares or a combination) and potential adjustment mechanisms (e.g. earn-out clauses) are described.
3. Conditions
The conditions that must be met for the transaction to be finalised are defined here. Typical conditions are
- Completion of due diligence without any significant negative findings.
- Approval of the competent authorities, e.g. competition authorities.
- Consent from third parties, such as banks, strategic partners or important customers.
- Timetable for the M&A transaction
4. Timetable for the M&A transaction
A realistic timeframe is crucial to making the transaction process efficient. The LOI therefore often contains information on:
- Planned deadlines for due diligence
- Dates for contract negotiations and the so-called signing
- The targeted closing date of the transaction, the so-called closing
5. Legally binding and non-binding elements
The LOI should clearly state which parts of the document are legally binding. While the transaction terms often remain non-binding, clauses on confidentiality, exclusivity and assumption of costs are usually legally binding. In rare cases, a so-called break-up fee is provided for in the event of a breach of exclusivity or withdrawal from the process without good cause.
Exclusivity: when does it make sense – and when not?
One of the most important potential points of contention when negotiating an LOI is the issue of exclusivity. With this, the seller undertakes not to conduct negotiations with other parties (so-called negotiating exclusivity) or not to conclude a final agreement with another buyer (so-called closing exclusivity)
Naturally, sellers do not want exclusivity so as not to put themselves in a weaker position. During the term, they cannot build up competition or examine alternatives.
From a certain point onwards, however, it is customary to agree exclusivity. However, this should only take place when:
- The buyer has examined the issue on the most important points and the further process is primarily about confirming previous assumptions.
- The buyer can demonstrate that it has involved its decision-making bodies and that a takeover has been agreed in advance within the company.
- There are no unresolved economic issues and the key points of the contract, in particular the guarantee regime, have been agreed.
Exclusivity protects the buyer. But it also gives the seller side the bandwidth to work towards the transaction it wants with full vigour.
Conclusion: The LOI as the key to a successful M&A process
The letter of intent is an important instrument in the M&A process that helps to structure negotiations and align the transaction parties towards a common goal. By clearly formulating the key points, the LOI creates transparency and trust, while legally binding clauses protect important interests. However, in order to minimise potential risks, it is crucial to draw up the LOI carefully and with legal support. This ensures that it serves as a solid foundation for the next steps in the M&A process.
