Merger and acquisition activity is on the rise. Whether you are hoping to acquire a competitor to strengthen your business or looking to protect your business through an M&A, it's important to understand the process. One of the key components of the M&A is the letter of intent (LOI). Those involved in M&As should know what a letter of intent is and when to use it.
What Is a Letter of Intent for a Merger?
The letter of intent in the M&A process is a nonbinding offer from the buyer indicating a serious interest to buy the seller's business. Coming before the official M&A due diligence phase, the letter of intent is an important way to make sure that both parties are in alignment. Think of it as a screening tool: If there is a mismatch between the buyer's vision and the seller's, proceeding with the deal will waste time and resources on both sides.
What Is the M&A Letter of Intent Format?
Some parties prefer to keep the letter brief and discuss only the most salient parts of the deal. Why discuss everything if there isn't consensus on the main issues? Other parties would rather avoid a potential surprise at the last minute and spell everything out in verbose letters that can run up to 10 pages.
While length varies widely, nonbinding offer M&A letters tend to follow a structure.
These letters typically contain the following:
- Structure of the deal: This spells out how the deal will be structured. For example, is it a stock purchase?
- Terms and considerations: While the LOI is nonbinding, it nonetheless spells out conditions that must be met to close, a projected closing date and acceptable forms of payment — such as cash, earn-outs or equity.
- Exclusivity period: Buyers tend to request exclusivity periods for consideration of their deal.
- Break-up fee: If the deal falls apart after agreement, there is usually a fee due to the seller — 3% is common.
- Due diligence: Since due diligence will proceed if there is agreement on the intent letter, it's common to spell out the type of information that will be included and expectations for disclosure.
- Confidentiality: The LOI typically comes after a nondisclosure agreement, but confidentiality is reiterated through this clause.
- Approvals: If either party needs approvals from third parties, such as boards or agencies, this will be listed here.
- Escrow: This clause sometimes appears in the LOI if the buyer wants to escrow some of the deal profits to cover any past liabilities that emerge post-M&A.
LOIs are not a mandatory part of M&As, but there are good reasons to perform them.
Terms may change after due diligence when the buyer has a more complete picture of the seller's business, its assets and its liabilities.
The LOI checks the temperature of the deal in terms of agreement. It brings to the surface any deal-breakers, so the parties can determine the best resolution. Negotiation is possible in some cases — in others, it's best to walk away. Determining this before significant resources have been invested saves both sides time and resources.
By setting expectations early, the LOIs can make the whole process more harmonious.
Lastly, certain clauses offer protections to buyer or seller. Sellers are protected by the break-up fee, which the buyer pays if the deal falls apart. Buyers are protected from the exclusivity period that prevents the seller from entertaining other offers until it expires.
How Do Both Sides Exchange the Letter of Intent for a Merger?
These days, it's common to use a virtual data room (VDR) throughout the M&A, including when exchanging the letter of intent.
The shared virtual space offers a secure, private environment for companies to interact. Meeting virtually is much easier than face to face, so it saves resources. It's also easier to upload documents to a private, encrypted VDR than to transport them to a conference room.
DFIN's M&A solutions software supports buyers and sellers with a secure, streamlined solution to manage and share files. Useful from the LOI through due diligence to the final negotiation, this M&A solutions software provides everything needed to successfully negotiate and close a deal.