<
Financial Poise
letter of intent

When Should a Seller Sign a Letter of Intent?

A letter of intent is used in the purchase and sale of a business to set forth the framework for the negotiation of definitive transaction documents and closing of a transaction. Normally, a letter of intent does not create a binding contractual obligation to purchase or sell the business.

However, a non-binding letter of intent does impose upon the parties the obligation to negotiate in good faith, transaction documents that contain the material terms set forth in the letter of intent. If one party breaches its obligation created by the letter of intent, the other party will have a claim to recover transaction expenses incurred, but will not have a right to the “benefit of the bargain.” This would occur only if there were a binding obligation to purchase or sell the business.

[Editor’s Note: This is part of a series of articles written specifically for the business owner who is thinking about selling. To start reading from the beginning, read “Business Transition and Exit Planning: Welcome to the Jungle!”]

Buyer Advantages

Strategically, it is advantageous for a buyer to execute a letter of intent as early in the process as possible, because a properly drafted letter of intent will grant the exclusive right to a buyer to complete due diligence and to negotiate definitive transaction documents.

This exclusive right to negotiate is a binding provision, exposing the seller to contractual damages if breached by him. It gives tremendous bargaining power to the buyer because during the exclusivity period, a seller is required to negotiate exclusively with the buyer, and cannot leverage one buyer against the other with respect to price and deal terms.

It is for this reason that a seller will want to delay the execution of a letter of intent as long as possible, and, if the company is in high enough demand, attempt to avoid the execution of a letter of intent altogether. A buyer, however, often, requires exclusivity before he will spend the funds necessary to complete due diligence. The seller will not proceed with a transaction if a letter of intent is not signed.

Buyer and Seller: Differing Objectives

The differing objectives of the buyer and seller not only impact the timing of the execution of the letter of intent, but also its content. From the buyer’s perspective, the exclusivity provision is the primary motivation in moving forward with a letter of intent. Therefore, the buyer wants to include as few material terms as possible, because once a letter of intent with an exclusivity provision is signed, the deal will only improve for the buyer.

As due diligence is completed, issues come to light and transaction documents are negotiated.  From the buyer’s perspective, the best possible position would be to enter into an exclusivity agreement without any terms. While a shrewd buyer might propose this, a seller should never enter into a “naked” exclusivity agreement.

A well-represented seller will recognize that the high water mark for its bargaining power is before the execution of a letter. Therefore, unlike a buyer, who would like to keep the letter of intent as minimal as possible, the seller will want to include the material terms of the deal as well as any terms which the seller views as critical to a successful transaction.

A seller does not benefit strategically from waiting until after the letter of intent is signed before raising critical deal terms. A good example is indemnification. A buyer will want to avoid the topic to the extent possible. At the same time, a seller will want to clearly delineate any caps on indemnification and other limitations on indemnity such as, possibly, baskets and de-minimus claim requirements.

Careful consideration the strategic underpinnings of a letter of intent with experienced corporate counsel will assist the buyer and seller in determining the optimal content and time to execute it in any particular transaction.

[Editor’s Note: To learn more about this and related topics, you may want to attend the following webinars: Legal and Practical Advice-Roadmap to Selling Your Business” and our article “The Letter of Intent-In Detail” by Peter Feinberg. This is an updated version of an article first published in April of 2015.]

Like what you just read?

Then sign up to receive our weekly Financial Poise newsletter, our take on the most relevant and topical business, financial and legal issues affecting investors and small business owners.

Always Plain English. Always Objective. Always FREE.

About Scott Adamson

No author bio available. Check LinkedIn for more information.

View all articles by Scott »

>