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Transaction Letters of Intent

3 minute read

If you are selling or purchasing a business, the first document that is likely to be involved is a letter of intent. This is a document that sets out in brief terms the agreement of the parties on the key business terms of the proposed transaction. It is non-legally binding with the exception of some non-business terms. The reason for this is that it enables the parties to reach agreement more quickly on the key business terms without taking the time at the early stages of the transaction to try and negotiate the more detailed legal terms such as the representations, warranties and indemnities that the purchaser will be asking for from the seller as due diligence proceeds and the full legally binding transaction documents such as the Share or Asset Purchase Agreement are negotiated.

Because the letter of intent is non-legally binding as to the business terms, both parties can deal with it more quickly and without the degree of detail which will be included in the legally binding agreements prepared later, in order to get the deal underway, without fear that they will be legally committing to something that they are not able to change later. Having said that, it is best to treat the letter of intent seriously and include a level of detail which will flesh out the key business terms such as the amount of the purchase price, how the purchase price will be paid, whether there will be any security given for any part of the purchase price not paid in full on closing, the specific assets or shares being sold, what debt of the seller is being assumed by the purchaser (if any), the scope of any non-competition covenant and other terms of a comparable nature, so that the parties are confident that they do have agreement on the terms which are key to them proceeding to invest their own time and resources and that of their advisors which will be involved in a full transaction.

It is common, as the transaction later proceeds through negotiation of legally binding documents, for the letter of intent provisions to be referred to by one party if the other party does want to deviate from a business term set out in it. Although the deviation will be legally possible, there may be a perception problem if an important business term which was specified in the letter of intent is later backed away from without a good reason. One reason for changing a term could be new information discovered during due diligence or a real change in the business between the time of signing the letter of intent and the later binding negotiations. However, if there is no good reason, there may be a serious problem with the trust that one party has in the other party's commitment to the transaction proceeding on a mutually agreed basis.

As indicated, there usually are some terms of a letter of intent which are specified to be legally binding. One of these is an agreement of the parties to each bear their own expenses in connection with the transaction. Another is a confidentiality clause in which the parties agree that all confidential information exchanged relating to their businesses and the terms of the transaction itself will be kept confidential. Finally, it is typical for a purchaser to ask the seller to include a binding "no shop" clause under which the seller commits for a specified period of time not to consider any other offers for the business or to negotiate with any other party. A purchaser typically does not want to proceed to invest the time and resources which will be required during due diligence and negotiation of the legally binding agreements without the seller committing to this type of exclusive negotiating period.

If the parties have negotiated the key business terms of the proposed transaction and signed a letter of intent along the above lines, they can more confidently proceed to spend the time and resources which will be necessary to complete the transaction with more extensive legally binding transaction documents.

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Greg Hatt

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