Marcus Vindictus: “Don’t you know your right flank from your left flank?”
Captain Mucus: “I flunked flank.”
Dialogue from the movie “History of the World- Part 1.”
I hate playing the acronym game – where certain people toss around terms they are sure others don’t understand. I guess it makes them feel smart. Having recently been involved in a few transactions, I have come to realize that a good number of the non-professionals involved in a deal do not understand what a Letter of Intent or LOI is. So, I thought it might be helpful to provide a layman’s view on the basics regarding this often-used and just-as-often-misunderstood instrument. This is, by no means, an in-depth analysis of all the components; just some education for entrepreneurs and their teams.
First, to begin to understand an LOI, it is important to have some knowledge of the sales process and where the LOI comes in. In the ideal transaction, you assemble a deal team, prepare an offering memorandum (OM) and circulate the same to potential buyers and then receive back an LOI. In some deals, there are two intervening steps; one is the seller may decide to perform their own due diligence and make that part of the OM and the other is obtaining an Indication of Interest (IOI) as a precursor to an LOI.
An IOI is a brief document that indicates a potential buyer’s desire to proceed further with the seller and may contain some basic outline of what a deal and related structure might look like. After further discussion, the potential purchaser usually generates an LOI. An LOI is a non-binding document between a potential buyer and seller. They key point is that it is non-binding so it is not a contract. The contract for a sale is usually called a Purchase Agreement and it is binding. So why have this non-binding document? The LOI can be a very valuable instrument and is recognized in the deal world as a milestone in moving from the “I think I have an interest in buying you” phase to the “I would like to buy you and here is what a deal would look like” phase. Let’s look closer at some of the key components (and here I am assuming this is a solid LOI.)
First, it should lay out the basic terms of the deal. The purchase price, structure (stock vs. assets), financing (including any contingency) and other terms should be outlined. While it may be subject to due diligence, it should provide a solid outline of deal basics.
Second, it should lay out overall timing – how long the offer will remain open, the timing of due diligence as well as the date to finalize a Purchase Agreement.
Next, it should allow for due diligence and cover non- disclosure / confidentiality. The LOI is often used as the benchmark for letting someone see what is “behind the numbers.”
Finally, there is usually an exclusivity period – the time the seller gives the potential buyer an exclusive right to complete diligence and negotiate a deal.
A well-written and negotiated LOI can become the basis for drafting a solid Purchase Agreement which is why it takes time to negotiate and sign. But as Yogi says, “it ain’t over till it’s over” and so nothing is a deal until the Purchase Agreement is signed. That being said, a solid LOI is a major step in completing a transaction.