Rapidly growing privately held companies are highly sought after acquisition targets. The signing of a letter of intent usually marks the beginning of what is hopefully a successful deal. Unfortunately, a signed letter of intent offers no guarantees that the acquisition will be completed. The following are tips that can help sellers realize certain advantages when negotiating a letter of intent as well as help them protect themselves from transactions that slip away and fail to close after the letter of intent is signed.
Avoid Fishing Expeditions. Not all buyers possess the same level of experience with acquisitions. Sellers should check the potential buyer’s reputation for signing a definitive agreement and consummating a transaction. Letters of intent also typically address the binding nature of confidentiality and non-solicitation of the seller’s employees, even if the acquisition is not consummated.
Negotiate the Letter of Intent. The seller’s leverage is greatest prior to signing the letter of intent because the buyer is at an informational disadvantage regarding the seller’s business. This advantage is lost as the buyer gains more information in the course of due diligence. Furthermore, until the letter of intent is signed, the seller generally does not have restrictions against "shopping" the deal. Sellers typically seize this opportunity to negotiate the letter of intent to ensure that important deal terms are not omitted and that it clearly reflects the seller’s understanding of the proposed transaction.
Carefully Consider the No-Shop. Time kills all deals. Long no-shop provisions are not advantageous to sellers. A buyer may find another transaction that it prefers, and it is difficult to get buyers to agree to not look at other deals. Typically, it is in the seller’s interest to keep the duration of the no-shop as short as possible, but consistent with completing the transaction in a timely manner. Sellers sometimes include a "kick out" provision that allows the seller to terminate the no-shop if the buyer is unable to recommit to, and confirm, the terms set forth in the letter of intent.
Clearly Identify Material Terms. Definitive agreements are most easily negotiated when the letter of intent provides a clear outline of the material terms of the transaction. A seller should negotiate all material terms of importance to it from the outset, such as purchase price, earnout metrics, holdback and escrow provisions, indemnity obligations, non-competition provisions, employee retention and compensation requirements, and closing conditions. Sellers typically resist the inclusion of terms that could delay or prevent the consummation of the transaction, such as allowances for open-ended due diligence or the inclusion of closing conditions that are completely within the control of the buyer. Additionally, it is helpful for the letter of intent to clearly identify the seller’s understanding of the intended tax treatment with respect to all consideration to be paid in connection with the transaction.
Avoid Agreements to Agree. Inexperienced legal counsel often leave complex, but important, provisions unaddressed in the letter of intent or subject to agreement by the parties in the definitive agreement, such as indemnification obligations. They may even leave basic terms, such as the transaction structure itself, unaddressed. Omitting such terms can lead to difficult and expensive negotiations over the definitive agreement or the introduction of terms not contemplated by the seller. Silence often can lead to arguments over whether such terms are "customary" or "usual" in such a transaction.
Prudent sellers should engage experienced legal counsel prior to entering into negotiations with a potential buyer. They can help sellers craft letters of intent that clearly reflect the seller’s understanding of the proposed transaction and that also maximize the potential for a successful transaction.