The Letter of Intent and Other Preliminary Matters in M&A Transactions
Mergers and acquisitions (M&A) can be a complex and time-consuming process, involving a significant amount of due diligence, negotiation, and legal documentation. One of the most important preliminary matters in an M&A transaction is the letter of intent (LOI), which outlines the basic terms and conditions of the proposed deal. While the LOI is typically viewed as a non-binding agreement, recent Ontario jurisprudence (Wallace v. Allen et al., (2009) 245 O.A.C. 206 (CA)) has shown that it can be interpreted as binding under certain circumstances.
For business people considering an M&A transaction, the potential risks and consequences of not properly drafting or negotiating a LOI can be significant. In this article, we will provide an overview of the LOI and its importance in M&A transactions, discuss the key terms that should be included, and offer guidance on how to avoid common pitfalls. Whether you are a buyer or a seller, this article will provide you with valuable insights into the preliminary matters that can impact the success of your M&A deal.
Key Components of a Letter of Intent
When engaging in a merger or acquisition (M&A) transaction, a letter of intent (LOI) serves as an essential preliminary document that outlines the key terms and conditions of the agreement. The LOI is a critical tool for both the buyer and seller, as it sets the foundation for the transaction and helps to manage expectations. In this section we will examine 7 key components of an LOI and discuss best practices for drafting a comprehensive and effective LOI.
1. Basic terms of the agreement
The LOI should clearly outline the basic terms of the agreement, such as the purchase price, payment terms, and any conditions precedent to closing. This section of the LOI should also address any material issues related to the transaction, such as the transfer of ownership, the treatment of employees, and any intellectual property rights.
2. Good Faith Deposit
Depending on the circumstances, the seller may ask for a deposit or option fee, and it is up to the parties to decide if and how much of the deposit will be refundable and what conditions must be met to qualify for a refund.
3. Exclusivity and confidentiality provisions
Exclusivity and confidentiality provisions are critical components of an LOI. Exclusivity provisions prevent the seller from soliciting or accepting other offers during a specified period, while confidentiality provisions protect the buyer's sensitive information from being shared with third parties. It is important to carefully consider the length and scope of these provisions, as they can impact the buyer's ability to conduct due diligence and negotiate favorable terms.
4. Due diligence requirements
The LOI should outline the scope and process of the due diligence review, which is an important part of any M&A transaction. This section should specify the information and documentation that the seller is required to provide, as well as the timeline for the due diligence process. It is important to establish clear expectations upfront to avoid delays or misunderstandings during due diligence.
5. Breakup fee provisions
Breakup fee provisions are common in LOIs and serve as a form of protection for the buyer. These provisions require the seller to pay a specified fee if the transaction is terminated for certain reasons, such as the seller's failure to satisfy a condition precedent to closing. It is important to establish clear and reasonable breakup fee provisions to incentivize the seller to fulfill their obligations under the LOI.
6. Conditions to closing
The LOI should identify any conditions precedent to closing, such as regulatory approvals, third-party consents, or financing requirements. This section should also specify the timeline for fulfilling these conditions and the consequences of a failure to satisfy them. Careful consideration of these conditions can help mitigate the risk of unexpected delays or complications during the closing process.
7. Closing and documentation
The LOI should specify the timeline for closing and the required documentation to complete the transaction. This section should also address any post-closing obligations, such as indemnification or earn-out provisions. It is important to ensure that the closing requirements and post-closing obligations are clearly defined in the LOI to avoid confusion or disputes down the line.
Common Reasons Why Deals Die at an Early Stage
It is common for M&A deals to fall apart in their early stages, leaving both parties frustrated and disappointed. It is essential to understand the reasons for such failures to avoid repeating the same mistakes in the future. The following are some of the common reasons for deal failures in the early stages:
Firstly, inadequate preparation by the seller is one of the leading causes of deal failures. The seller must provide detailed financial statements, reflecting the current condition of the company going back at least two years. Failure to do so can cause uncertainty and mistrust, leading to potential deal-breaking issues.
Secondly, uncooperative behavior by the seller and their team during the due diligence process can also lead to deal failures. The buyer needs to have full access to the necessary information and data to make informed decisions about the transaction. Uncooperative behavior from the seller can signal a lack of transparency, causing the buyer to lose confidence in the seller's integrity.
Thirdly, a significant "deal-breaker" discovered during the due diligence process can cause a deal to fall apart. This could be anything from unknown liabilities, such as environmental or regulatory issues, to contingent liabilities that the buyer may not be willing to assume.
Fourthly, the seller's decision-making can also impact the success of the deal. If the seller has not properly considered their after-tax consideration or compensation, they may experience "seller's remorse" or get "cold feet." Additionally, if the seller becomes defensive when the buyer finds flaws in the business, it can cause mistrust and further complicate negotiations.
Fifthly, a strategic shift in the buyer's acquisition strategy or criteria can also cause a deal to fall apart. This could be due to changes in the buyer's management team or external factors affecting their decision-making.
It is important to note that dealing with these issues requires careful planning and skilled negotiation. Consulting with an experienced business lawyer in Ontario can provide valuable guidance and ensure that both parties' interests are adequately protected. By addressing these common reasons for deal failures in the early stages, buyers and sellers can increase their chances of success and move forward with confidence in the transaction.
Final Thoughts
Failing to properly negotiate or draft these documents can lead to significant risks and consequences for both the buyer and seller. It is essential to carefully consider the key components of the LOI, such as the basic terms of the agreement, exclusivity and confidentiality provisions, and conditions to closing. Additionally, it is important to understand the common reasons why deals fail in their early stages, such as inadequate preparation, uncooperative behavior, deal-breaking issues, seller's remorse, and strategic shifts.
To circumvent these risks, it is advisable for the parties involved in the M&A transaction to engage the services of an experienced business lawyer, preferably one licensed in the province where the sale or purchase is taking place. The legal counsel can offer valuable guidance and ensure that the interests of both parties are safeguarded. By negotiating extensively and drafting the LOI carefully, the parties can enhance their chances of success and proceed with certainty in the deal. With meticulous preparation and a keen eye for detail, M&A transactions can present lucrative opportunities for both buyers and sellers.
Contributor Roberts and Obradovic Law
Opinions expressed here by contributors are their own.
BuyAndSellABusiness.com launched a private Slack community designed to help people connect, share insight and ask questions about buying, selling and growing businesses or franchises. Apply to join here.
Remember, if you are interested in receiving the latest business news, insights and opportunities from BuyAndSellABusiness.com, you can subscribe to our newsletter here. Also, if you are not a BuyAndSellABusiness.com user yet, what are you waiting for? Click here!
