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Richard Harroch, Contributor
In acquisitions of abreast captivated companies, a letter of intent/term area is generally entered into by both parties. The purpose of the letter of absorbed is to ensure there is a “meeting of the minds” on bulk and key acceding afore the parties expend cogent assets and acknowledged fees in advancing an acquisition, and afore sellers accede to admission exclusivity to buyers.
The purpose of this commodity is to analyze the key issues in negotiating and drafting an accretion letter of intent.
What Is About Included in a Letter of Intent?
A letter of absorbed can be abbreviate or long, depending on the dynamics of the negotiations and the desires of the parties. Here are the types of items that can be included in a letter of intent, a cardinal of which are discussed in greater detail afterwards in this article:
Price/Consideration—Will it be all cash, all or allotment stock, earnout, or promissory note? Adjustments to the acquirement price—Will it be a cash-free/debt-free deal? A alive basic adding and acclimation mechanism? Treatment of severance costs and transaction fees and expenses? Transaction structure— Will it be an asset purchase, acquirement of all outstanding shares, or a merger? Accepted timeline for due activity and negotiating the accord Any escrow to defended the seller’s apology obligations, how continued the escrow will last, and for what items the escrow will be the buyer’s sole antidote for claims Exclusivity for the -to-be buyer—How continued will exclusivity last? Back can the agent abolish exclusivity early? Access to the employees, books, and annal of the agent for the account of the client as allotment of its due activity action Ambit of key representations and warranties of the agent (will some key reps be accountable to accomplishment by a “materiality” or “knowledge” standard?) and adaptation aeon Whether any allocation of the application accustomed by key advisers will be paid out over time post-closing for purposes of application these advisers How agent agent options and disinterestedness captivated by advisers will be advised (will they be afflicted by the client or terminated?) and whether these are in accession to the acquirement bulk Activities banned by the agent awaiting closing Whether any third-party consents to seller’s key affairs will be appropriate or sought, as a aftereffect of the accretion The acquaintance obligations of the parties apropos the transaction (and alluringly a non-disclosure acceding will already be in abode by the parties) How seller’s advisers will be hired/treated by the client Continuing apology obligations of the client for seller’s officers, directors, employees, and stockholders, pursuant to any absolute Apology Agreements or allotment accoutrement Altitude to closing the transaction, both for client and agent Whether any non-compete/non-solicit agreements will be appropriate Apology obligations by the affairs stockholders and the banned and exclusions from such apology accoutrement How and back the accretion acceding can be concluded How disputes will be handled and in what administration
Short-Form vs. Long-Form Letter of Intent
Long-form belletrist of absorbed are added absolute and accurately constructed, and advised to ability a affair of the minds on abounding of the key acceding of a abeyant deal. The key advantages of a long-form letter of absorbed are:
Issues that can be accord breakers are articular aboriginal on and resolved, afore spending cogent acknowledged fees and administration assets for both the client and seller. Resolution of cogent issues aboriginal on can accomplish the action of extensive a absolute accretion acceding easier and added efficient, with consistent accumulation in time and acknowledged fees. If an important affair surfaces as insurmountable, for sellers it is bigger to apprentice that early, rather than apprentice about it back the agent is in exclusivity and a abortion of discussions at that point could be added damaging or difficult for the seller.
The primary disadvantage of a long-form letter of absorbed is that it may bog bottomward the drive of getting a accord done, as the parties accord with too abounding difficult issues aboriginal on. It may additionally aftereffect in the breakdown of the negotiations that could accept been abhorred if assertive issues had been deferred.
A short-form of letter of absorbed will usually alone abode the bulk and conceivably a few key acceding (such as any escrow holdback for seller’s apology protection, breadth of escrow, and the exclusivity/no boutique appropriate for the buyer) and has the advantage of actuality quicker to accommodate than a long-form letter of intent. The accessible disadvantage is that it leaves abounding important issues to be apprenticed afterwards on.
The Affairs Company’s Perspective
From the angle of the affairs company, it will about appetite the letter of absorbed to be as abundant as accessible on the key issues of the deal. The acumen is that already a letter of absorbed has been active and an exclusivity negotiating aeon has been accepted to a buyer, the advantage in the negotiations will beat to the buyer. Therefore, the agent will generally appetite to accept a complete account of the bulk and accord acceding afore it is apprenticed up and precluded from talking to added abeyant buyers. And the added abundant the letter of intent, the added acceptable that a absolute accretion acceding can be adjourned successfully. The best time to get key concessions from a client is back the client believes there are aggressive bidders and area it does not accept exclusivity.
For accepted mistakes by sellers in acquisitions, see 22 Mistakes Fabricated by Sellers in M&A Transactions.
The Buyer’s Perspective
From the buyer’s perspective, abnormally area the client has ample negotiating leverage, it will favor a short-form letter of absorbed which includes a continued aeon of exclusivity in acclimation for it to accomplishment its due activity and accommodate a absolute alliance or accretion agreement. The client about will altercate that it can’t accede to some of the key acceding of the accord in the letter of absorbed until it completes its due diligence. (The agent will altercation that argument—the client can accede to key terms, but if problems appear in its due diligence, it is consistently chargeless to renegotiate any provision.)
In some situations, it is in the buyer’s absorption to additionally accept a abundant letter of absorbed to abstain spending lots of administration assets and acknowledged fees on a accord that ability not get consummated.
Binding vs. Non-Binding Acceding of the Letter of Intent
The letter of absorbed will about accompaniment that it is non-binding, except for assertive appointed provisions. Usually at this date in the accretion process, neither the client nor the agent are accommodating to be apprenticed to achieve a transaction. Further, the letter of absorbed does not accommodate all the acceding that should be agreed aloft in an acquisition.
Nevertheless, assertive accoutrement are about appointed as bounden such as:
Confidentiality – The letter of absorbed and its acceding should be agreed to be arcane and about accountable to the non-disclosure acceding amid the parties. Exclusivity – The ambit and acceding for exclusivity accepted to the buyer. Expenses – Statement that the parties anniversary buck their own costs or, in some instances, whether one affair (usually the buyer) will awning some of the added party’s expenses. Conduct of the Business – Buyers sometimes assert that sellers accede to accomplish the affairs company’s business alone in the accustomed advance and burden from assertive actual actions. Altercation Resolution – The parties sometimes accede that any disputes surrounding the letter of absorbed would be apprenticed alone by arcane bounden arbitration.
The letter of absorbed should acutely accompaniment which portions are bounden and which are not. Lack of accurateness on this point ability acquiesce a cloister to accomplish (or debris to enforce) a accouterment adverse to the absorbed of the parties.
Exclusivity for the Buyer/No Shop
The client will about assert on a bounden exclusivity/no boutique aeon area the agent and its officers, directors, representatives, advisors, employees, stockholders, and affiliates may not appoint in any discussions or negotiations with, accommodate advice to, or access into agreements with any added -to-be buyer. The agent is additionally precluded from “shopping” the buyer’s bid or the company. The exclusivity accouterment will additionally about crave the agent to anon abolish any added auction discussions. The client will additionally ask that it be notified of any analysis or offers from added abeyant buyers during the exclusivity period, and the acceding thereof (including the character of the third party).
The agent will appetite to accumulate the exclusivity aeon abbreviate (for example, 7-14 days) and the client will about appetite best (for example, 30-60 days). The agent should assert on a book that allows it to abolish the exclusivity aeon aboriginal if the client afterwards proposes a lower bulk or materially worse terms, or if the agent believes in acceptable acceptance that the parties are not authoritative acceptable advance on finalizing a accord or the client is not befitting up with the time table agreed to by the parties (discussed below). The client will, of course, abide giving the agent a base to abolish exclusivity aboriginal back the client will activate spending abundant assets on administering due activity and advancing documentation. In abounding instances, the accommodation will be an exclusivity aeon somewhat beneath than the client desires.
In attenuate instances, such as a accessible alliance of equals transaction, both parties will accede to exclusivity.
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Price for the Acquisition
The bulk for the accord is acutely the key issue, but the letter of absorbed should accomplish clear:
Whether the bulk will be paid all banknote up front. If banal is to be allotment or all of the application offered by the buyer, the acceding of the banal (common or preferred), defalcation preferences, allotment rights, accretion rights, voting and lath rights, restrictions on transferability (if any), and allotment rights. If a promissory agenda is to be allotment of the buyer’s consideration, what the absorption and arch payments will be, whether the promissory agenda will be anchored or unsecured, whether the agenda will be affirmed by a third party, what the key contest of absence will be, and the appropriate to advance acquittal of the agenda aloft a aperture by the buyer. Whether the aggregation will be “debt chargeless and banknote free” at the closing or whether the client will accept assorted indebtedness. Whether there will be a alive basic acclimation and how alive basic will be calculated. This is ultimately aloof an acclimation up or bottomward to the acquirement price. The client may altercate that it should get the business with a “normalized alive capital” and the agent will altercate that if there is a alive basic acclimation clause, the ambition alive basic should be zero. This alive basic mechanism, if not appropriately drafted, could aftereffect in a cogent acclimation in the final acquirement bulk to the damage and abruptness of the abnormally afflicted party. If allotment of the application is an earnout, how the earnout will work, milestones to be met (such as revenues or EBITDA and over what aeon of time), what payments are to be fabricated if milestones are met, what protections will be offered the agent to enhance the likelihood of the earnout actuality paid, advice and analysis rights, etc. Earnouts tend be the antecedent of accepted disputes and sometimes litigation. Precision in drafting these accoutrement and accordant on acceptable altercation resolution processes are essential.
Timeline for the Acquisition
Sometimes it is advantageous to set alternating in the letter of absorbed dates by which the parties apprehend assorted affairs to be completed, such as:
Back the online abstracts allowance (the basic allowance area the seller’s key abstracts and affairs are housed) will be fabricated accessible to buyer. Back the aboriginal abstract of the accretion acceding and exhibits will be presented by one affair and back aboriginal comments will be provided Back due activity is to be completed by the client The accepted signing date of the accretion acceding The accepted closing date
Limitations of Liability/Indemnification
In clandestine aggregation acquisitions, the agent about indemnifies the client for breaches of representations fabricated in the accretion contract. Apology finer adjusts the acquirement bulk downwards and accordingly the acceding of apology are about consistently the accountable of diffuse negotiations.
The agent (and its stockholders), able-bodied acquainted that their acceding advantage will abatement already the letter of absorbed is signed, frequently will assert that the letter of absorbed set alternating limitations on the ambit of this apology obligation. In contrast, buyers will about resist, asserting that acceding of the acceding of apology should be deferred to the acceding of the absolute accretion agreement, at which time the client will be abundant bigger abreast about the seller’s business and liabilities. Although bazaar convenance today is to specify the admeasurement of an apology escrow and the admeasurement to which it ability be the sole antecedent of accretion for client apology claims, it is sometimes difficult for sellers to access in the letter of absorbed added limitations on its (or its stockholders’) apology obligations.
In some deals, the agent with advantage can booty the position that the accord should be structured like a accessible aggregation blazon deal—that there is no escrow and that representations, warranties, and covenants expire at the closing. An escrow in clandestine aggregation acquisitions is acclimated to defended the seller’s apology by acceding an agreed bulk of the banknote acquirement bulk into an escrow. The agent will altercate that if the client wants added protections, it can do so through its own accurate due activity and by accepting the protections afforded by M&A representation and warranties insurance.
Indemnification obligations may bound in a array of ways, such as:
The agent should adapt a abounding and absolute acknowledgment agenda laying out all appropriate disclosures beneath the accretion acceding to abate the accident that the client will seek apology for aperture of the seller’s representations and warranties. The agent should seek a concise bound escrow (5%-10% of the acquirement bulk for 9-12 months) to be the absolute recourse for aperture of the seller’s representations and warranties. Of course, buyers will seek above escrows and best time periods. Although it has become accepted for the parties to an accretion to accede to acquiesce the client to seek accretion above the escrow (or afterwards it has been disbursed) for breaches of assertive “fundamental representations,” in every acceding the agent should anxiously accede insisting that the buyer’s recourse for apology be bound to the escrow. The agent will appetite “fundamental representations” to alone abide of those apropos to due authorization, due organization, and enforceability of the accretion agreement. However, some buyers will altercate that representations about capitalization, tax matters, bookish acreage matters, and fees owed to admiral additionally abatement in the brazier of “fundamental representations.” Sellers acerb abide such a provision. The agent should accomplish abiding that adaptation periods for breaches of accepted representations and warranties are no best than the appellation of the escrow, except with account to “fundamental representations.” To the admeasurement that apology may be appropriate by the affairs stockholders beneath the accretion agreement, that apology should be “several” (i.e., pro rata) and not “joint and several” accountability (which would accomplish any distinct stockholder accountable for all of the losses declared by a buyer). In addition, the agent should assert that no indemnifying stockholder be accountable for added than the bulk of auction gain absolutely accustomed by the indemnifying stockholder. Added limitations that are adjourned accommodate the dollar beginning afore apology is required, caps on the indemnity, exclusions or carve outs from the indemnity, limitations on what types of losses a client may recover, and the admeasurement to which a buyer’s ability of an blunder in the seller’s representations confined indemnification.
Representations and Warranties
The letter of absorbed will about not accommodate a abundant advertisement of the seller’s representations and warranties. But if the agent desires to accept assertive achievement or ability qualifiers for accurate representations and warranties, it may be best to accommodate these in the letter of intent. For example, the agent may appetite to accompaniment that any representations and warranties apropos bookish acreage contravention issues be bound by a ability qualifier.
To the admeasurement there are any key agent issues for the agent or buyer, it may be advisable to abode these in the letter of intent. Such issues could include:
Whether the client will accept the seller’s unvested agent banal options (and whether that acceptance is a answer of the acquirement price). The types of advantage and allowances to be fabricated accessible to seller’s advisers by buyer. The hiring of any key executives, the key acceding of employment, and the admeasurement to which the closing of the accretion is conditioned aloft such key advisers entering into application agreements with the buyer.
Conditions to Closing of the Acquisition
The agent will appetite to set alternating key altitude to closing (and alluringly will appetite the letter of absorbed to set alternating the only conditions to closing). That way, the agent will accept a bigger compassionate of the likelihood of a closing.
The archetypal closing altitude that a agent will acquiesce for the account of the client include:
The accurateness and accuracy, in all actual respects, of its representations and warranties in the accretion agreement. The acquiescence by the agent of its covenants in the accretion agreement, in all actual respects. The accepting of any all-important authoritative consents (such as Hart-Scott-Rodino Antitrust approvals).
The client may additionally assert on the afterward closing conditions, amid others:
The accepting of consents that may be appropriate from third parties beneath key contracts, that may be triggered by the acquisition. Absence of any action gluttonous to adjure the transaction or any action actual to the seller. The beheading of application agreements with key admiral of seller. The beheading of non-compete and non-solicitation agreements by the stockholders (venture basic and institutional investors about never accede to these). No actual adverse change in the business of agent amid signing of the accretion acceding and closing (the agent will assert on assorted exclusions to this condition). The accepting of costs (sellers will acerb abide this as a closing condition, arguing it introduces too abundant ambiguity and is alfresco of the seller’s control). Commitment of audited banking statements of the agent to accredit the buyer, if the client is a accessible company, to accede with its balance law advertisement obligations. Commitment by the agent of the accord to the accretion by the holders of a actual aerial allotment of the seller’s outstanding disinterestedness and commitment by such stockholders of abutment agreements waiving dissenters’ rights, accordant to accumulate aggregation and transaction accompanying advice confidential, and accordant not to advertise their banal except to the buyer.
It is adorable for the letter of absorbed to set alternating how and area resolution of disputes will happen, both beneath the letter of absorbed and beneath the accretion agreement.
My alternative is for a arcane bounden arbitration/provision, beneath the JAMS bartering adjudication rules in actuality at the admission of the arbitration, afore one adjudicator called by JAMS. In deals involving all-embracing parties, all-embracing adjudication firms (such as the All-embracing Chamber of Commerce) should be advised for this purpose.
Such an adjudication accouterment allows for faster and added cost-effective resolution of disputes than litigation. Action can be acutely cher and aftermost for abounding years during any address process.
Among the issues to be advised with account to an adjudication accouterment are the cardinal of arbitrators, the area of the arbitration, the ambit of discovery, the time aeon for resolution, and who will buck the fees and costs of the arbitrator. I additionally about adopt a accouterment that states that anniversary affair will pay its own acknowledged fees and costs, and 50% of the arbitrator’s fees.
A well-drafted letter of absorbed can access the likelihood of an accretion auspiciously closing, on optimal terms. To see some sample belletrist of intent, analysis out the Forms and Agreements section of Media
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