What is an LOI?
If you are selling your business, the potential purchaser may present you with a Letter of Intent, or ‘LOI’, which is a document entered into between the purchaser and seller setting out key transaction terms. An LOI allows the parties to ensure they are aligned on key deal terms before undertaking substantive work. Most commonly, the LOI will specify that it is non-binding, except for certain provisions such as those related to confidentiality and exclusivity.
The terms of the LOI form the basis of a more comprehensive and binding purchase agreement that will be negotiated and ultimately executed by the parties. Below we touch on some of the main considerations and recommendations for sellers who are considering an LOI.
What are the implications of signing an LOI?
While most provisions of an LOI are non-binding, the LOI is still viewed as an agreement in principle on the general terms of the transaction, meaning it can be difficult to change the terms at a later date. A request to deviate from the LOI on a substantive deal point may not be well-received. Therefore, the LOI can have significant influence on how the transaction unfolds with that purchaser.
As noted above, the exclusivity provisions of an LOI are usually binding and are intended to restrict the seller from entering into discussions to sell the business to any one other than the purchaser party to the LOI for a specified period following execution, typically ranging from thirty to ninety days. Accordingly, an LOI can limit a seller’s opportunity to sell the business to another purchaser, even if a better offer presents itself.
Matters to be addressed in the LOI and Considerations for Sellers
LOIs will vary depending on the nature of the transaction and the industry, but listed below are key components to be considered for most LOIs:
| Parties and Shares/Assets for Sale | The LOI should identify the parties to the transaction and the target entity(ies) or assets to be sold. If the seller has multiple corporations or businesses, it is important to identify which are part of the transaction. If any key assets will not be included in the sale, this should be clearly set out in the LOI. |
| Confidentiality | The Seller will want the LOI to include a binding requirement that information pertaining to the business, disclosed in connection with the transaction remains confidential. Given that the disclosure of confidential information could be detrimental to the business should the transaction not proceed, it is ideal if the parties have entered into a separate, comprehensive non-disclosure agreement even before the LOI stage. |
| Purchase Price and Satisfaction | The LOI should set out the total purchase price, as well as details related to timing and manner of payment, such as:
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| Transaction Structure | Proceeding by way of share sale vs. asset sale can have important implications for the taxes payable by the seller, as well as the liabilities incurred by the purchaser. |
| Closing Conditions | Many transactions are structured with an interim period between signing the purchase agreement and the date of closing. Closing conditions may allow a party to decline to close despite the signed purchase agreement, such as if the purchaser requires financing, or is waiting on deliverables from the seller. Given the significant expense of a transaction, the seller will want to be aware of any such conditions that may allow the purchaser to walk away. |
| Non-Competition Obligations | If the seller intends to continue operating in the industry after closing, it is of particular importance that the seller is aware of the scope of any restrictions on competition contained in the LOI. |
| Indemnification Obligations | A purchase agreement will typically include representations from the seller about the business, together with requirements for the seller to indemnify the purchaser for losses it may suffer if those representations are inaccurate. To protect the seller, an upper limit will often be placed on the seller’s indemnification obligations. Indemnification obligations can be a challenging negotiation point, and reaching a consensus at the LOI stage can be helpful in ensuring a smooth transaction. |
Takeaways
A seller should have their legal and financial advisors review the LOI before signing, so the seller has a clear understanding of the implications of the terms presented and can receive guidance on negotiating alternative approaches.
Having a comprehensive and carefully considered LOI in place prior to proceeding with a transaction can save sellers time and money by ensuring the parties are in agreement on major deal terms before incurring significant transaction costs.