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The Anatomy Of A Letter Of Intent

In the exciting and jargon filled word of mergers and acquisitions, you may often find reference being made to a letter of intent. But what exactly is a letter of intent (LOI)? Given the importance of an LOI it is crucial to answering this question, as well as other common questions we come across when dealing with LOIs.

What is an LOI?
The best way to describe an LOI is to think of it as a roadmap to a transaction. An LOI typically outlines the terms and conditions of an offer from a buyer to a seller. Expressed otherwise, an LOI is a written expression of a buyer’s intention to purchase the business of a seller and together with its terms to the seller indicates the buyer’s intention for the transaction.

What is the difference between a binding and non-binding LOI?
Unlike most contracts, the terms of an LOI are typically non-binding unless the parties agree that the whole or certain parts of an LOI are binding.

It is therefore important for sellers to remember that the terms contained in the LOI may not always be the terms that the buyer and the seller settle on (assuming, of course, the parties agree that the terms are not wholly or partially binding).

What are the common terms of an LOI?
While each LOI will be different, certain recurring themes appear. The most common ones are:

1. The parties
Although this seems obvious, it is critical that the correct parties are cited. Large corporations tend to have various subsidiaries and affiliated companies, and it is important for both parties to understand who exactly they are dealing with.

2. Structure of the transaction
This part of an LOI will describe how the transaction will be concluded. Is the transaction a purchase of the shares, a sale of assets, or a combination of both? Depending on the jurisdiction in which the transaction takes place, the structure will have to be carefully considered to ensure that parties are aware of how exactly ownership will change.

3. Consideration
The consideration is the payment that the seller will receive from the buyer. There are various ways in which to structure consideration. For example, the buyer can agree to pay a portion upfront with the remaining portion being paid subject to certain conditions being met once ownership changes.

4. Purchase price adjustments
Purchase price adjustments are used to adjust the purchase price for movements in working capital accounts (such as accounts receivable, inventory, and accounts payable) between the execution of the LOI and the transaction being finalised.

5. Conditions to closing
This part of the LOI will include the expectations and obligations of the buyer and seller, which are specific to them. For example, a buyer may need to get approval from regulatory bodies prior to concluding a transaction.

6. Confidentiality and non-disclosure clauses
Following the signature of an LOI, a buyer will typically receive sensitive information from a seller regarding its business. In addition, a seller may receive sensitive information from a buyer. It is crucial to agree on what information may be disclosed, to whom the information may be disclosed (such as accountants and legal counsels) and for what period the information needs to remain confidential.

7. Exclusivity
LOI’s typically include an exclusivity provision in terms of which the buyer asks the seller not to negotiate with other prospects for a pre-determined time period. As a seller, it is within your best interests to ensure that the exclusivity period is as short as necessary and that the terms are well defined.

What are the benefits of an LOI?
A properly drafted LOI will address key terms, remove ambiguity and thereby benefit both the buyer and the seller as it often reduces the amount of time and costs spent on revisiting negotiating.

Many business owners will only sell a business once in their lifetime. When dealing with such a monumental event, a little more preparation today is certainly worth added value tomorrow. Advice from seasoned professionals can provide you with savings in costs and time in helping you sell your business. At Benchmark International, we are proud to provide world-class mergers and acquisitions services.


Author

John Lousber
Transaction Associate
Benchmark International

T: +27 (0) 21 300 2055
E: loubser@benchmarkintl.com

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Tips For Evaluating A Buyer’s Letter Of Intent

A Letter of Intent (“LOI”) is an expression of the buyer’s intent to acquire a seller’s business on specific terms and conditions.  It is considered a milestone in the transaction process, primarily because it is predicated on the concept that the seller and buyer have agreed upon the basic terms, assuming that due diligence supports assumed facts.

An LOI is generally non-binding as to substantive terms (price, transaction structure, and forms of consideration) but is often binding as to process items. These include access to seller’s information, cooperation by the parties, seller’s exclusivity obligations, seller’s obligation to conduct business in the ordinary course, governing law, confidentiality, and allocation of expenses.

Sellers need to manage their expectations and be aware that buyers can still walk away from the deal even after they have reviewed sellers’ sensitive information provided in due diligence.  If the buyer is a direct competitor, this can have unintended consequences for the seller, notwithstanding well-drafted non-disclosure agreements with limitations on use of the information.  For example, will a strategic buyer determine through due diligence that investing the purchase price in their own business is more cost-effective than paying an acquisition premium?  It is critical that the seller and his/her advisor carefully evaluate all offers and determine if the buyer has the actual intent and financial wherewithal to close the transaction before signing the LOI.

 

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Here are some basic considerations for evaluating an LOI.

  • Is the deal too good to be true?Reasonable business practitioners do not offer consideration or terms well above the norm.  Such offers often end in re-trades or worse, in a long period of failed efforts to secure acquisition financing, during which time the seller’s business is off the market because of exclusivity.
  • How will the buyer finance the transaction? Cash at closing or bank debt. Third-party financing adds significantly to the complexity and timing considerations of the transaction.The seller should consider requiring satisfactory evidence of a financing commitment early in the process, with the ability to break exclusivity, and perhaps recover out of pocket costs if it is not provided in a timely manner. 
  • How will the seller be compensated? Will the seller receive the full purchase price in cash at closing?What indemnification provisions (how much for how long) apply?  Is rollover equity a component of the deal?  Is stock of the buyer a component of consideration?
  • Is the transaction cash-free/debt-free?If so, does the seller’s balance sheet indicate that a substantial portion of sale proceeds go to retirement of debt?
  • Does the transaction include a working capital adjustment?Assuming that value is based upon a stream of cash flows, a “normal” level of working capital (that historically facilitated the income streams used to determine value) will be required at closing.  Careful attention must be given to how this issue is treated in the LOI, and in the asset or stock purchase agreement, because working capital adjustments (based upon factors determined in a quality of earnings review) are often used as an effective re-trade by sophisticated buyers.
  • What post-closing involvement is required of the seller?Will the seller be required to continue in the business post-closing?  For how long and for what compensation?
  • What non-competition requirements are required?Most acquisition agreements include a non-competition provision that lasts from two to five years.  The points for consideration include geographic location, limitations on the type of business precluded, passive investment versus active participation, and the overall length of time the limitations are effective.

It is crucial to understand that an LOI is not the end of the transaction process, but for legalities.  It is, in effect, just the beginning. Due diligence and quality of earnings review, drafting the asset purchase agreement, and financing the acquisition are all yet to come.  The terms of the LOI can have a serious affect on the seller’s ability to realize his expectations through this process.

 

Author
Don Rooney 
Transaction Director
Benchmark International

T: +1 813 898 2350
E: Rooney@BenchmarkIntl.com

 

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What is included in the M&A due diligence?

The due diligence process is one of the final steps in an M&A transaction where the potential buyer does its obligation to best confirm and verify the seller's company data and relevant information. This information typically includes but not limited to: financials, IT, operations, legal & compliance, insurance, corporate bylaws, contracts, customers, among other important information. Typically, the due diligence process follows the execution of a letter of intent (LOI), a non-binding document outlining the intent of both parties to commit to the transaction.

Once the LOI has been executed, the buyer will request a list of items to be shared by the seller with the intention of disclosing the selling company’s key details that could uncover risk buyer. As mentioned before, items can range all the way from financials to operations to insurance to contracts, among others. In cases where the seller owns the real estate, additional documents pertaining to the real estate, such as: deeds, mortgages, tax documents, owners’ insurance, etc. will need to be provided. Given today’s advancements in technology, once the due diligence request list has been sent to the seller, the team leading the deal will proceed to open what we call in the M&A world a “virtual data room” or a “data room.” These two terms are referred to as online portals that hold and store the information requested by the buyer with high levels of security only available for certain parties, including: buyer, seller, M&A attorneys, CPAs, advisors, among others. The data room allows activity within the room to be tracked and archived so there is a file of the information exchange after closing should any issues arise.

Once the due diligence starts, it is highly recommended for the buyer to hold, at the very least, weekly meetings or calls with the seller to discuss outstanding items or any questions that may have arisen from the process. As the due diligence process progresses, the buyer will become more familiar with the seller’s company. For an instance, should the buyer find any items that may play against the seller in the due diligence process, the buyer may use this to lower the valuation of the business which may ultimately result in a lower offer price.

In addition, this process can result as a discovery of potential opportunity to better structure the deal, find real synergies among parties, review any benefits and challenges for potential system integrations, and any associated risks that may arise from the result of this potential acquisition. 

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Letter of Intent for Mergers and Acquisitions

In a corporate merger or acquisition, it is imperative to make sure that both companies involved are on the same page in the early stages of the process. M&A is complicated and require costly resources, therefore it is important to know what each party is prepared to offer before proceeding with the transaction. One method to make sure that both parties are on the same page is to draft and produce a letter of intent (LOI), which outlines the deal points of the merger or acquisition and serves as a type of “agreement to agree”.

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