Letter of Intent
The “Letter of Intent” (LoI), which in German would likely be translated as “written declaration of intent,” is a central component of an M&A transaction. The Letter of Intent reflects the status of negotiations at the time it is drafted. At the same time, however, it is merely a non-binding declaration of intent. The Letter of Intent is negotiated jointly following the conclusion of initial exploratory talks and thus marks the transition to detailed purchase negotiations.
Significance of the Letter of Intent
Even though the Letter of Intent is not binding, it should by no means be treated lightly. It sets the course for future negotiations. Once certain contractual terms have been set forth in a Letter of Intent, they usually cannot be easily revoked. It is also important that significant matters of principle and potential “deal breakers” are clarified before the buyer gains extensive access to the company’s internal documents as part of the due diligence process.
Contents of the Letter of Intent
A Letter of Intent typically contains the following provisions:
1. Description of the transaction and the parties involved
One of the most important points in the Letter of Intent is the question of what exactly is for sale. Is it the holding company along with all its subsidiaries? Are business premises that the owner may still hold in their private capacity also being sold?
2. Purchase Price and Payment Terms
A typical Letter of Intent (LoI) identifies the parties, states the intention to enter into a contract, and outlines the key terms and conditions of the agreement, such as price, payment terms, delivery terms, guarantees, and warranties. It may also include information about the planned timeline for the final negotiations and the execution of the contract.
3. Structuring Options
In addition to the purchase price, the question arises as to how it will actually be paid. Various structuring options are possible here. For example, the seller might be willing to provide a portion of the purchase price as a “vendor loan.” In this case, financing the transaction becomes significantly easier for the buyer. Alternatively, it would also be possible, for example, to include an earn-out clause, under which a portion of the purchase price is paid from the company’s future profits.
4. Exclusivity and Break-up Fees
Buyers often try to pressure the seller to agree to exclusivity, meaning the seller would not conduct parallel negotiations with other buyers. This dramatically limits the seller’s options, as it precludes potential bidding competition among different buyers. Break-up fees refer to an agreement regarding potential penalty payments that become due if a party withdraws from the contract negotiations.
5. Confidentiality
Unless an NDA has already been signed, it is essential to enter into a confidentiality agreement before the due diligence process begins. This ensures that the company’s confidential information is treated as such.
Summary
Overall, the Letter of Intent plays a crucial role in the transaction process. It sets forth the issues related to the transaction that are particularly important to both parties prior to the start of the due diligence process and the final contract negotiations. Since additional information often comes to light during due diligence, it is all the more important for buyers and sellers to use the Letter of Intent to establish a solid foundation in advance for the subsequent final purchase price negotiations.