Introduction. A key component to any successful merger and acquisition (M&A) transaction is the letter of intent (LOI). A thoughtfully negotiated and comprehensive LOI establishes specific and critical deal terms prior to drafting the definitive purchase or merger agreement, rather than engaging in the more arduous process of negotiating deal terms through extensive (and expensive) drafts of those definitive agreements. An effective LOI establishes whether there really is a “meeting of the minds” between the parties that can survive the rigors of the transaction process. Negotiating a comprehensive LOI at the beginning of an M&A deal substantially improves the likelihood of successfully closing the transaction, is more cost effective for both parties, and makes the drafting process more efficient and better coordinated. Although most of its provisions are non-binding, the LOI is often considered to be the good faith understanding of the parties and a roadmap for the definitive agreement.
Key Considerations. The following are some key considerations in negotiating and drafting a comprehensive LOI out the outset of an M&A transaction:
1.Structure of Transaction. Analyzing and considering tax consequences on both sides of the transaction are paramount before agreeing to one of the three common M&A structures:
–Merger: a transaction where a surviving company (i.e., the buyer) merges and combines with the seller (i.e., the acquired company) with the seller ceasing to exist post-closing. The buyer also generally assumes by operation of law all the assets and liabilities of the seller, making the indemnification considerations critical for the surviving company in a merger transaction.
–Purchase and Sale of Assets: a transaction where the buyer purchases most or all of the assets and customarily assumes limited specified liabilities of the seller. The buyer can limit its risk of inheriting unwanted and unknown liabilities of the seller through an asset transaction.
–Purchase and Sale of Equity: a transaction where the buyer purchases the equity of the seller from its owners (i.e., stockholders, members, partners, etc.). Like in a merger, the buyer is acquiring the seller in its entirety and effectively absorbing and assuming all of the seller’s liabilities (and also similar to a merger, making the indemnification considerations critical for the buyer in an equity transaction). Unlike a merger, the seller typically continues to exist and operate in some capacity post-closing in an equity transaction as a subsidiary of the buyer.
2.Purchase Price / Consideration. The price can take different forms, with all cash or part cash and part of the purchase price in the form of an earnout, promissory note, equity in the buyer, and/or a combination of the foregoing. An all cash purchase price provides the most certainty and least risk. However, a seller may be able to obtain a higher purchase price by agreeing to have some of the purchase price contingent or payable at a later time. Your M&A advisors can help you navigate through the different structures and pros and cons of each.
3.Post-Closing Management. As part of the LOI, consider, negotiate and provide for (if applicable):
-The continuation of the owners, key management, employees, or contractors of the seller with the buyer post-closing.
-The material terms of post-acquisition employment or consulting arrangements anticipated.
4.Due Diligence. Provide for the scope, period and timing of the due diligence necessary for the buyer to adequately evaluate the seller (and for the seller to evaluate the buyer, particularly in instances where a portion of the purchase price will be contingent on post-closing operations of the buyer or equity in the buyer will be issued as part of the purchase price).
5.Other Strategic Considerations. Evaluate and consider obtaining consensus in the LOI regarding:
-Categories of representations and warranties to be given by the seller and, if applicable, the owners of the seller.
-Indemnification liability limitations based on prevailing market terms (which are accessible through market deal study statistics readily available to M&A professionals). These apply if a party breaches the definitive agreement.
-All other major deal points important to either party should be considered for inclusion, such as whether:
-Any material consents or approvals (including regulatory approvals) must be obtained by either party as a condition to closing.
-The buyer will require any non-compete agreements or transition arrangements.
-The buyer will assume any liabilities of the seller.
6.Binding Elements. The LOI is generally non-binding, except for certain specific exceptions that apply prior to a definitive agreement being signed, such as:
-Nondisclosure and confidentiality.
-“No-shop” or exclusivity rights for the buyer that prohibit the seller from negotiating offers from other parties while the LOI is in place.
-Costs and expenses (the expenses incurred as part of the LOI and negotiating the transaction are typically stated in the LOI that each party pays its own expenses).
Key Advisors to Consider as Part of the LOI Evaluation and Negotiation.
-Experienced M&A legal counsel.
-Investment banker, business broker or other experienced M&A advisory professional(s).
-Qualified M&A tax and audit professionals.
Conclusion. The LOI is a critically important aspect in the negotiation and pre-drafting process of an M&A transaction. If evaluated, negotiated and drafted properly, an LOI can effectively establish each party’s expectations of the fundamental deal terms, provide detailed guidance for the drafting of the definitive agreements, and delineate a focused path to close the transaction consistent with each party’s intentions and expectations. Linden Law Partners has extensive experience developing, negotiating and drafting LOIs for M&A transactions of all structures, sizes and scopes across a variety of industries. We provide key value driven advice to our clients about LOIs. Feel free to contact us here.