The Business Purchase Letter of Intent
Today’s post discusses an important early step when you are purchasing a business: drafting and negotiating a business purchase letter of intent. The process of drafting and negotiating a business purchase letter of intent generally follows the initial negotiation of the major business purchase terms. Those material terms—price, payment method, closing timing, and basic conditions to the sale—are generally negotiated directly between the parties on smaller business purchase and sale transactions. On larger transactions, the parties and their brokers and investment bankers negotiate those terms.
After you agree on what each party is going to do as part of the business purchase, one party (often the buyer) will distill those main business terms into a written document that is the business purchase letter of intent. The letter of intent acts as a blueprint for drafting the final deal documents, helps both parties to reach an agreement on the material terms early in the process, and helps ensure any remaining issues get “out on the table” so they can be resolved early.
Letters of intent are a type of offer, and should be considered carefully. There are many details to consider in a stock or asset purchase agreement that are not covered in the letter of intent. This post will detail the terms typically included in a business purchase letter of intent.
A letter of intent should outline the purchased assets, which could include units of an LLC or shares of a corporation. The “purchased assets” are what the buyer is actually buying and the seller is actually selling. Parties often agree generally on what’s being bought or sold, but that agreement may be based on assumptions about what each party considers to be part of the deal. By writing down the specific assets or stock each party believes is changing hands, the parties ensure they are actually speaking about the same thing and not relying on assumptions.
The purchased assets section in a stock or units sale should describe exactly the number of shares or units being purchased and type of shares or units (for instance, common stock or preferred stock or both). The purchased assets section in an asset sale should be specific and detailed, and it should cover whether all intellectual property, all inventory, and all accounts receivable will be included. You will also want to consider whether or not company bank accounts, investments, warranties, and other rights and assets are considered “purchased assets.”
While there are (potentially significant) differences between stock and asset sales, the specific liabilities assumed in a sale should be covered in the letter of intent regardless of structure. In a stock sale, the buyer will generally assume the liabilities that are associated with or attached to the stock. In that case, the letter of intent will simply clarify that expectation. In an asset sale, the buyer is often structuring the transaction as an asset purchase to avoid assuming certain liabilities. But even in an asset sale there may be liabilities the buyer must assume. If so, those liabilities should be specifically described, including how and when they will be transferred.
Another critical (perhaps obvious) section in a business purchase letter of intent is the purchase price. The letter of intent should detail what the buyer is actually going to pay for the purchased assets, how much the seller will receive for the purchased assets, when that payment or those payments will be made, what accounting assumptions underlie the value, and whether any funds will be held back at closing to ensure the seller’s performance of its obligations.
Additionally, it is important to detail exactly how the purchase price will be paid. For instance, will it be paid over time or paid all at closing? Will the seller finance any part of payment, or will there be any other financing contingency? What will secure the payment (if any payments are made over time), and how much payment is going to be held back by the buyer to help cover contingencies of the seller after closing (for instance, performance or indemnification contingencies)? Perhaps counterintuitively, the purchase price section is often one of the most detailed and extensive sections in a business purchase letter of intent.
Conditions Precedent to Closing
Conditions precedent to closing (also called “conditions of (or to) closing”) simply means “what has to happen before the deal will be finalized?” That is, these conditions to closing outline what must happen between signing the letter of intent and the closing date for the business purchase to be finalized.
Examples of conditions to closing include completing due diligence, obtaining financing, obtaining regulatory approvals, and negotiating third party contracts (for instance, a new commercial lease). Buyers and sellers may need to get approvals from their board of directors or shareholders, or negotiate employment agreements with key employees to ensure that after the closing any key employees will continue to work for and grow the new business.
Another condition often included is a requirement of no “material adverse changes” in the business before closing. If something happens before closing that materially changes the business or the business’ prospects, the buyer may want an “out” to reconsider the deal. The buyer is generally justified in getting this “out,” as it reasonably protects the buyer from being forced to move forward with the purchase if something integral to the business changes unexpectedly. But sellers will often negotiate the definition of “material adverse change” heavily to avoid sinking costs into a sale where the buyer can easily walk away.
The letter of intent often outlines not only a requirement of no material adverse changes, but also the seller’s obligation to keep the business going as usual during the negotiation period.
Confidentiality clauses are included in a business purchase letter of intent to describe how information shared between the parties should be protected and what information cannot be shared without the other party’s consent. The confidentiality clause is, in effect, a non-disclosure agreement. This section should describe what the parties are to do with the information they receive from each other, as well as what each party is able to say about the deal in order to facilitate it. A confidentiality clause should have provisions that allow buyers and sellers to talk to their advisors, including their attorneys, accountants, broker, and investment advisors. The letter of intent should also include in the confidentiality section or a separate section whether either party can make public announcements about the potential sale and how each party will handle those announcements.
The letter of intent should also detail expenses. The primary questions that the business purchase letter of intent should answer are what are the anticipated expenses, who is required to pay those expenses, and will those parties pay the expenses regardless of closing the sale? Examples of expenses that may arise and need to be accounted for are administrative expenses associated with setting up document transfers, regulatory expenses, public relations expenses, accounting and similar professional expenses, and escrow-related expenses.
Another expense-related clause that often gets its own separate section in the letter of intent is indemnification. Indemnification seeks to protect a party, say the seller, from a third party claim that arises out of the actions of the buyer. So if the buyer incurs liabilities or expenses from a third party, and then the third party tries to hold that against the seller, will the buyer indemnify the seller for the cost to resolve the issue? The letter of intent should give you the answer.
Termination and Bid Expiration
The termination section of the business purchase letter of intent will outline how parties will end the business purchase if they decide not to go through with it, and it will detail the provisions of the letter of intent that will survive and be binding after termination. Though the majority of the terms in a letter of intent are generally non-binding, the confidentiality clause, the exclusivity clause, the indemnification clause, and other related clauses are often binding.
The letter of intent will normally include a description of exactly what terms in the letter of intent are binding. And it will also detail when the “offer” (the latest draft of the letter of intent) will expire. While the bid expiration is not necessarily required if the letter of intent is non-binding, the bid expiration still serves as a signal to the other party of how long you are willing to wait for them to consider your proposal for the terms of the transaction.
Governing Law and Venue
Establishing the governing law for the letter of intent is important, particularly if there are binding provisions. The governing law and venue section covers how disputes over the letter of intent will be resolved, including any requirements for arbitration or mediation. A related provision is whether either party will be able to get attorney’s fees if the other party breaches the letter of intent. For more information on governing law and venue, check out this post.
Each business purchase is unique, so each business purchase letter of intent should be unique. This list of provisions is by no means exhaustive, and you will likely want to include other provisions in your letter of intent. But anyone considering buying or selling a business will want to consider whether their letter of intent should include these basic provisions.
If you would like to learn more about business purchase letters on intent or business acquisitions generally, please contact us today.