What to Expect From a Letter of Intent

by Seth Rubin, Esq.

It happens all the time.  Business people get together, strike up a conversation and – before you know it – a deal has been struck.  However, at this point, the “deal” exists only in the form of some scribbled notes on a napkin from the restaurant where the business meeting took place.  Enter the lawyers who, in many cases, will advise the parties to memorialize their deal in a letter of intent.  But what terms should be included in a letter of intent, and are they binding?  What should parties expect from a letter of intent?

The answers to these questions are not clear cut.  They depend, in part, on the parties’ understanding of what the deal is supposed to encompass and also on how much time the parties have already spent discussing the deal.  In some cases, this may be very limited (“I agreed to sell my business and she agreed to buy it”) and in other cases, the parties may have spent weeks trying to resolve every last detail of the transaction before even thinking about a letter of intent.  Usually, the answer lies somewhere in between and a letter of intent can be used effectively to determine the ground rules and parameters for negotiation.

At a minimum, a letter of intent should be able to achieve certain basics: (A) set forth the fundamental terms of the deal  – Is it a stock purchase, an asset purchase or some other type of deal? What is the purchase price and how will it be paid?; (B) identify certain major conditions that must be satisfied before either party is required to close  – e.g. bank financing, regulatory approval, or third party consents; and (C) determine which parts of the letter of intent will be binding and which will be non-binding.

Of course, Buyers and Sellers each want binding provisions that protect their respective interests.  Sellers are typically interested in protecting themselves against the possibility that a proposed deal will collapse, word will leak to the press and the public that the business is for sale, competitors will swarm like sharks, and their business will be ruined.  Buyers, on the other hand, want to keep Sellers from creating a bidding war among multiple potential buyers and driving the price of the transaction to a point where it no longer makes sense to make the deal.

Fortunately, if crafted properly and the parties are reasonable, a letter of intent can accomplish the goals of both Buyers and Sellers.  Among other things, a letter of intent should contain confidentiality provisions requiring that all documents exchanged by the parties (subject to certain widely acknowledged exceptions) should be kept confidential and that no party should publicly disclose the negotiations between the parties or even the existence of a letter of intent.  In exchange for the time, effort and money being expended, a Buyer wary of a bidding war may rightfully request a “no-shop” clause which prohibits a Seller from negotiating with other potential buyers for a specified period of time.  During this time, the Buyer will have the option but not the obligation to buy Seller’s business.  Typically, the longer the time period in a no-shop clause, the better it is for the Buyer.  Depending on the relative strength of the parties and the dynamics of the deal, in exchange for such a provision, the Buyer may be asked to deposit with the Seller a good faith deposit of some portion of the purchase price which the Seller may keep in the event the deal is not closed by a certain date.

Beyond these basics, it is debatable whether there is a benefit to including more detail.  What is clearly undesirable is to have a letter of intent that becomes so over-negotiated that the cost of the document (in terms of time and money spent in drafting it) outweighs the benefit.  In certain cases, parties may wish to consider an alternative to a letter of intent.  One possibility is a term sheet, which is similar to a letter of intent in the topics it covers, but typically does so in more summary fashion and is customarily viewed as (and states that it is) non-binding.  The parties won’t get all the advantages of a letter of intent but at least will have succeeded in identifying important issues for negotiation.  Another possibility is to skip the term sheet or letter of intent altogether and move immediately to definitive documentation.  If initial negotiations are extensive and detailed, it may pay to avoid a letter of intent so that the parties don’t wind up with two sets of negotiations  – one at the letter of intent stage and one at the definitive documents stage.  There are risks and benefits in each scenario.

If parties ultimately choose to use a letter of intent, it is important that the letter of intent reflect the intentions of the parties as accurately as possible, whether or not a given provision is intended to be binding.  This is because a letter of intent, for better or worse, will be used as a template for the definitive documents to be negotiated by the parties.  Departures from the terms of the letter of intent will need to be justified and may come at a cost.  As importantly, many business people feel that once a letter of intent has been executed, the parties are obligated (morally, ethically or otherwise) to close a deal in accordance with the stated terms.  For this reason, and other reasons described in this article, a letter of intent can be both a blessing and a curse.  Before entering into a letter of intent, or deciding to forego the use of one, be sure to consult with counsel experienced in business transactions.


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