Before a buyer and seller enter into a definitive written agreement for the sale of a business, the seller may be presented with a letter of intent or term sheet setting forth the key terms and conditions upon which the buyer proposes to acquire such business. Typically, a letter of intent or term sheet is initially prepared by the buyer and its counsel after preliminary discussions regarding the proposed sale have commenced but before significant amounts of time and money have been spent on due diligence. The letter of intent or term sheet thereafter may be negotiated to a greater or lesser extent by the parties depending on the scope and level of specificity desired by the parties with respect to the key terms and conditions of the proposed transaction.
What are letters of intent and term sheets?
A letter of intent is a letter from the buyer to the seller in which the buyer states its intent to reach a definitive agreement with the seller for the acquisition of the seller’s business. The letter typically sets forth certain material terms and conditions upon which the business will be acquired and, consequently, represents the preliminary understanding of the buyer and seller regarding the proposed sale. The letter may not contain all of the essential terms of the transaction, however, and may expressly state that the parties will attempt to reach a definitive written agreement within a specified time frame.
In lieu of a letter of intent, the buyer may deliver a term sheet to the seller. A term sheet typically sets forth the most important terms and conditions relating to the proposed sale in the form of a list rather than a formal letter. In addition, unlike letters of intent which are signed by both the buyer and the seller, term sheets are not necessarily signed by the parties.
What topics are typically addressed in letters of intent and term sheets?
Despite the difference in form, letters of intent and term sheets tend to address similar topics. For example, a letter of intent or term sheet may address some or all of the following issues:
- the proposed structure of the transaction (for example, an asset purchase, stock purchase or merger), including, to the extent applicable, the specific assets that will be purchased and not purchased, any liabilities of the seller to be assumed by the buyer, the class or classes of seller’s stock to be acquired, the parties to the merger and the identity of the survivor
- the purchase price and any purchase price adjustments, including whether any portion of the purchase price will be held in escrow
- the nature of the consideration to be paid by the buyer (for example, cash, a note, shares of stock or a combination of the foregoing)
- the due diligence process to be undertaken by the parties, including what information the seller will make available to the buyer and what access the buyer will have to the seller’s employees, records and facilities
- any conditions that must be satisfied prior to closing the transaction (for example, obtaining financing or third party, stockholder or government approvals)
- any confidentiality provisions that may prevent the parties from disclosing information they obtain during the due diligence process, even if a separate confidentiality agreement has already been entered into by the parties
- any non-solicitation provisions (“no shop” or exclusivity provisions) that may prohibit the seller from negotiating with other potential buyers
- any non-compete provisions that may prohibit the seller from competing with the buyer in a defined geographic area for a specified period of time
- the payment of certain expenses relating to the transaction
- indemnification provisions and any related limits
- what will happen to the seller’s employees after the transaction is consummated
- when the letter or term sheet will terminate, either by mutual agreement of the parties, upon a specified date, or otherwise
The process of negotiating a letter of intent or term sheet may help the buyer and seller to identify significant issues that could derail the transaction before it goes any further and may facilitate the preparation of a definitive written agreement by memorializing key terms and conditions of the proposed sale that the parties have already agreed upon. The value of a letter of intent or term sheet, however, must be weighed against the reality that the time spent negotiating such a document could have been spent preparing a definitive written agreement. Moreover, sellers should be aware that non-solicitation provisions in a letter of intent or term sheet may prevent them from negotiating with other potential buyers.
Are letters of intent and term sheets binding?
Letters of intent and term sheets represent the preliminary understanding of the parties regarding a proposed sale and, as such, may be either binding or non-binding. In some cases, the parties may want a letter of intent or term sheet to be binding in its entirety. In most cases, however, either the buyer or the seller, or both, do not want to be obligated to consummate a proposed sale before the parties have actually entered into a definitive written agreement. The parties, therefore, may want only certain provisions of a letter of intent or term sheet to be binding immediately (for example, the confidentiality, non-disclosure or non-solicitation provisions and/or the provisions relating to the payment of expenses). Letters of intent and term sheets should expressly state which provisions of the document are binding on the parties. If the intent of the parties to be bound, or not to be bound, is clearly stated in the letter or term sheet, such intent presumably should be given effect by a court in most cases; however, potential buyers and sellers should be aware that a court could conceivably infer the contrary intent if the document is silent, or less than clear, on the matter.