The signing of a so-called Letter of Intent (abbreviated as LoI or, in German, “Erklärung der Absicht”) is essential in corporate transactions, as—when properly structured—it serves as a litmus test at a relatively early stage of the process to determine whether the seller and buyer can agree on the key parameters of a transaction. For the LoI to fulfill this important function, it should include key components. Conversely, omitting these components—in order to facilitate the conclusion of the LoI between the parties by deliberately setting low “barriers” and to “move forward” with the process—is not recommended.
So what are the essential components of a letter of intent?
In addition to formal elements such as the identification of the contracting parties, the subject matter of the transaction, and provisions regarding (non-)binding nature, these primarily include the economic terms of the transaction. This includes, in particular, the proposed purchase price with a specification of the method (locked-box or closing accounts) as well as the economic closing date. Potential purchase price components in the form of an earn-out or a seller’s loan should also be discussed and agreed upon by the parties at an early stage. In addition, the parties should agree on the next procedural steps, including a timeline, to ensure a process that is as efficient and effective as possible for both sides. Even though anonymized documents may be used during the subsequent due diligence phase, it is in the seller’s interest to agree to confidentiality, non-competition, and non-solicitation clauses enforceable by penalty, as extensive company details will be disclosed to the buyer.
The seller should pay particular attention to any exclusivity clauses in the LoI. While so-called “closing exclusivity”—as the name suggests—merely prohibits the closing of the transaction with a third party and thus allows for parallel negotiations with other prospective buyers, “negotiation exclusivity” prohibits even the latter. Given the significant restrictions such clauses impose on the seller in connection with the planned sale of the company—including obligations to bear costs in the event of a breakdown in negotiations—they should be accepted with caution and only for a limited period of time. Finally, clear provisions regarding the allocation of costs between the parties, potential dispute resolution procedures, the applicable law, and the venue for litigation round out the letter of intent.
Conclusion:
As the name “letter of intent” suggests, the majority of the provisions in the LoI are not legally binding. Nevertheless, it should not be overlooked that, based on experience, the terms agreed upon between the parties take on de facto binding force. As a rule, no reputable party will deviate from the agreements in the LoI during the subsequent process without good cause. Consequently, when “fully” drafted to include the essential contractual elements, the LoI helps determine whether it makes sense for both parties to invest time and effort in the subsequent steps of the transaction—particularly the time-consuming due diligence process. The time spent discussing and agreeing on these elements is well spent. After all, experience shows that—provided the due diligence process subsequently proceeds satisfactorily for the buyer—the transaction is highly likely to be completed. Both parties should be advised by experienced attorneys and M&A consultants, both during the drafting and negotiation of the letter of intent and during the discussion of the purchase and assignment agreement.
