In our efforts to demystify the world of investment banking, I thought it would be a good idea to walk through a document that is often misunderstood by clients. The Letter of Intent, or LOI, is a document that lays out a set of terms under which the buyer is willing to complete the deal. Having this document allows all parties to negotiate with a common understanding of value and expectations.
Before you sign an LOI make sure you review it carefully, paying close attention to all parts that are binding. This is generally a non-binding agreement, but some of them can contain specific paragraphs that are binding to the parties. Most of the time the binding paragraph is the confidentiality provision, which means that neither party can blab about being in talks with each other. Other times, the binding provision is an exclusivity paragraph. This means that you are limited to talking to only this buyer once you sign the LOI. Check with your investment banker before you move forward with an LOI that has an exclusivity provision. Signing a document with an exclusivity provision has the effect of chilling all other buyers and can limit your negotiating leverage substantially.
What Else Do They Need?
After the parties sign this document, the buyer generally hands over an incredibly long checklist of items they would like to review. Even if a buyer has received a Confidential Information Memorandum and has spent time in your data room, they will still give you a long list of questions. This list will seem overwhelming, but usually, many of the items can be dismissed with information the buyer has already received or by checking off items that are not applicable. In any case, review the information you are providing with your investment banker. Sellers tend to get loose with their information after an LOI has been signed because they feel like the major terms of the transaction have already been hammered out. However, sensitive information must be transferred carefully, even at this stage. The deal isn't over yet and you don't want to equip a competitor with information that is proprietary to your company.
Things Can Change
Once the bulk of the checklist items have been provided, the buyer may come back to you with another version of the LOI. They may find something during this intensive due diligence period that causes them to change the purchase price, or one of the terms to which you had previously agreed. In this way, the LOI is never a static document. It can change forms multiple times.
At this point, the seller and his or her advisors need to look at the offer in its new form and decide if such changes are negotiable. If you still like the deal after any secondary changes, then you continue onto the next phase of the transaction: drafting of the purchase agreement.
The LOI Isn't the End, It's the Beginning
Remember that the LOI is an outline of the transaction terms you expect to see in the purchase agreement. Do not over-negotiate the LOI and do not feel like you need to negotiate every term of the agreement at this stage. Doing so can chill a transaction. Your investment banker will help you establish what are LOI-type terms to negotiate and which terms can wait until you are discussing the purchase agreement.
In the second part of this series, we will explore what not to do once you have signed an LOI.