BUYING AND SELLING A BUSINESS: Letters of Intent and Term Sheets
After the parties have sufficiently addressed confidentiality issues, the negotiations can get going in earnest. Anxious parties want to move straight to a contract and sometimes in a small deal that can be done. However, it is generally much more efficient and cost effective in terms of professional fees to take the time to prepare either a letter of intent (“LOI”) or term sheet to guide the preparation of documents and due diligence efforts in at least general ways. These are usually regarded as containing points for negotiation and are not intended to create a binding commitment on either party. While to some extent it is a matter of the temperament of the parties as to how detailed these become, generally the more detailed they are, the more efficient the drafting and the due diligence will be.
Usually, a term sheet or LOI will include some general range of purchase price, description of what exactly is being purchased, and set out a timeline for closing the transaction. It may also address things like when and how due diligence will occur and what additional contracts also must be entered into, such as employment agreements or key vendor agreements, in order for the transaction to be concluded. It may also address financing needs.
As beneficial as these preliminary outlines are, there are some traps for the unwary. Some buyers will want to include binding provisions in a LOI. These may include things like a “no shop” clause for a period of time while the deal is being negotiated, a prohibition against soliciting customers or employees of either party during this process, or a requirement to conduct business in a certain way for a period of time to see if a deal can be put together. There is nothing wrong with containing some binding terms in a LOI, but the binding terms and the non-binding terms should be clearly and unambiguously identified. Case law is filled with instances where parties inadvertently bound themselves to terms that they thought were merely points of negotiation. To avoid these consequences, care needs to be taken in constructing the LOI.
Before the explosion of electronic communication, a rule of thumb to avoid the problems with LOIs was to use an unsigned term sheet. The thought was that if there is no signature, there can be no contract. Unfortunately, there are many reported cases where information that one party thought he or she was exchanging via email for negotiating purposes was later found by the court to have formed a contract. There is no doubt that in this day and age a contract can be formed by email and that a manual signature on a piece of paper is not required to form a binding contract. So even the exchange of term sheets via email needs to be done very carefully and the wording of email needs to be very carefully drawn.
So, at this point we have addressed confidentiality and gotten through the LOI or term sheet phase, making no more binding agreements than both parties intended. Now we need to consider the role of due diligence in the transaction. That will be the subject of our next article.