In mergers and acquisitions, a letter of intent or term sheet can clarify expectations and responsibilities to both parties. The primary purpose is to ensure the parties agree to key terms before they utilize significant resources in pursuit of an acquisition. Here’s what to include, and how to structure an acquisition letter of intent.
What Does a Letter of Intent Typically Include?
Letters of intent don’t have to follow a specific length or format. The right content depends on the needs and goals of each party. The following are items generally included:
Price or consideration: Will there be a cash sale, or will stock be included? Is there an earnout or a promissory note?
Purchase price adjustments: Will the deal be cash or debt-free? Include a working capital calculation and adjustment? How will it treat transaction fees, taxes, and severance costs?
Timeline: How long you anticipate it will take to negotiate and close the sale.
Structure of the transaction: Is it a purchase of shares? A merger? An asset purchase?
Whether escrow will secure seller indemnification obligations, the length of the escrow period, and which items the escrow will serve as a claim remedy for.
Exclusivity: Is there an exclusivity period, and how long will it last? Under what circumstances can it be terminated?
Access to books, records, and employees so the buyer can proceed to due diligence.
Warranties and key representations: What is their scope? Will key representatives be subject to a materiality or knowledge standard? What is the survival period?
Whether and to what extent consideration paid to employees will be paid over time to retain those employees.
Identifying key actors involved in the deal-making process, and their obligations to preserve and protect confidentiality.
How options and equity held by employees will be treated. Are they terminated or assumed by buyer? Are they in addition to the purchase price?
Whether any activities are prohibited pending closing.
The role of third-party contracts.
Confidentiality obligations of both parties. This should be in addition to a non-disclosure agreement.
Whether employees will be hired by the buyer, and how they will be treated.
How continuing indemnification obligations will function.
Conditions that must be met to close the deal.
Any non-solicit or non-compete agreements that will be necessary.
Whether, when, and how the acquisition agreement can be terminated.
How and in what jurisdiction disputes will be handled.
Short or Long-Form Letter of Intent?
Long form letters of intent cover more ground and address more legal issues. Their advantages include:
Identifying and resolving potential deal breakers early.
Resolving significant issues early, to make the process more efficiently.
Early knowledge of any potentially insurmountable issues.
Providing mutual understandings and a starting point for negotiations and discussions.
The primary concern with long form letters of intent is that they can slow the deal making process. Devising such an agreement takes time, and it forces the parties to address too many difficult concerns early on—before they’ve established a relationship, and sometimes before the seller has developed sufficient interest in the sale to keep going. It can even cause negotiations to break down. In some cases, this breakdown is avoidable when difficult issues are deferred to later in the process.