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Letters of Intent — Are They Worth It?

Who would think a non-binding document could create so much stress when you are putting a deal together. A letter of intent (LOI) is such a document. Simply stated, an LOI which may also be referred to as a “memorandum of understanding (MOU)” or “term sheet” expresses the intention of two parties to do something. While the purpose of such letters is to facilitate transactions by proactively addressing potential areas of disagreement, the question of whether to use an LOI can itself become a point of contention.

Letter of Intent

Opposing Views

Whether an LOI is worth the time and trouble stirs opposing views:

  • Pro-LOI: This side views the LOI as an efficient, inexpensive and quick way to determine whether the deal is even worth the time of the two parties to engage in negotiations.
  • Anti-LOI: This side thinks the better approach is to draft a more detailed deal document from the very start and then sort out any issues.

Disagreement also arises over the depth of detail to include in an LOI, assuming you want to use one. Often when dealing with the purchase and sale of assets, the prospective buyer will want to use an LOI with some binding covenants that tie up the seller to negotiate exclusively with the prospective buyer for some period of time. The prospective buyer wants to avoid wasting time negotiating with a seller who may be entertaining one or more competing offers. The seller often pushes back because (understandably) the seller wants to avoid being locked in until they know enough about the deal and are reasonably confident that the prospective buyer will make a good faith effort to follow through. As a result, consideration over the depth of detail to include in the LOI becomes a balancing act between detail, speed, and goodwill.

Two Key Considerations

One of the keys to working through this issue is to determine whether the use of an LOI is customary in the industry in question. The answer to this question does not necessarily change the mind of one side or the other, but it may tilt the balance in favor of using an LOI, which may enable you to proceed to making a deal.

If use of an LOI is customary, then there may also be customary depth. I have not found uniformity in the level of depth because each player in the LOI generation process has different interests. For example:

  • Buyers are likely to push for clear economic methodologies or processes.
  • Sellers tend towards hard numbers and certainty.
  • Brokers often push for vagueness to allow the LOI to be executed as quickly as possible and let the details get sorted out later.

Why I Favor Using a Letter of Intent

I have found that LOIs are a useful tool whether I am representing the buyer or the seller. I find that the process of trying to lay out the proposed transaction and hit its high points is beneficial. As I work with an LOI, I try to identify and clarify the key points in the industry that have caused problems in the past. These could be non-compete agreements that come into play after closing, earn out methods, and since I have expertise in the automotive dealer space — used car valuation or asset valuation metrics.

If I am able to focus the parties on the core issues that each side understands are sensitive points and address those in the LOI, the two parties then have a solid foundation after execution to move forward, and overcome the normal deal bumpiness to hopefully reach a definitive agreement.

One situation in which I have found the Letter of Intent to be especially helpful is when the buyer and seller are not in the same industry or they participate at different points in the industry. If a financial buyer is new to an industry, disconnects or blatant misunderstanding between the buyer and seller are likely to arise over industry-specific concepts and issues. The LOI process here can be beneficial to get both sides using the same language and to focus each side on concepts that are important to other side. The LOI also has the ability to ensure that buyer and seller at least understand the deal in the same way. The two sides may have differences in the future and experience some degree of frustration, but the LOI likely will allow the two foreigners to start to communicate and move forward.

While it is not a perfect vehicle, when properly used and its purpose is understood, a well-constructed Letter of Intent can be significantly helpful to getting a deal started in the right direction and setting the proper tone between the parties.

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Disclaimer: The information in this blog post is provided for general informational purposes only, and may not reflect the current law in your jurisdiction. No information contained in this post should be construed as legal advice from Stephen Dietrich, nor is it intended to be a substitute for legal counsel on any subject matter. No reader of this post should act or refrain from acting on the basis of any information included in, or accessible through, this Post without seeking the appropriate legal or other professional advice on the particular facts and circumstances at issue from a lawyer licensed in the recipient’s state, country or other appropriate licensing jurisdiction.

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About The Author: Stephen Dietrich is an attorney and author who has a passionate interest in the human side of business. His distinctive combination of legal and business knowledge, human insight, and dedication to clients makes him uniquely qualified to help corporate leaders and other C-level executives navigate high-value mergers and acquisitions, restructure transactions, and manage day-to-day operations. Through this blog, Stephen shares his extensive experience and unique personal and professional insights in the hope of stirring thought and dialogue that leads to ever deepening insights and understanding. For more information, please visit www.StephenDietrich.com.

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