M&A and the Letter of Intent (LOI)

M&A and the Letter of Intent (LOI)

Author: Joris Kersten, MSc

Kersten Corporate Finance: M&A advisory, and valuations, at The Netherlands. www.kerstencf.nl

Training: Business Valuation & Deal Structuring (5-day training), 4th – 8th November 2024 @ Amsterdam. www.joriskersten.nl

Source used: Closing the deal, Jacob Orosz, Morgan & Westfield.

?

Introduction

The major characteristics of a Letter of Intent (LOI) in M&A are:

·???????? The non binding character;

·???????? It is a moral obligation;

·???????? If offers (often) exclusivity for a buyer;

·???????? Limited information is offered at this moment in time;

·???????? Contingent on Due Diligence (DD).

?

Within an LOI there can be many undefined terms, like:

·???????? Working capital in the purchase price;

·???????? Exclusivity period;

·???????? Holdback (to what extend, in relation to purchase price);

·???????? Purchase price itself, including structure.

?

Concerning undefined terms, be careful here as a seller.

This since buyer will draft the final purchase agreement, so these undefined terms will be translated first into the advantage of the buyer.

A tip is here for the sellers to define as many terms as possible in the LOI.

Moreover, the exclusivity period should be kept as short as possible for a seller.

This since you loose negotiation power here.

Overall, for seller it works best to carefully negotiate the LOI with as many defined terms as possible.

And then later rush to close the transaction (when the LOI is signed).

But do NOT rush into an LOI.

?

Content of an LOI

Here are some examples:

·???????? Purchase price and terms;

·???????? Share deal vs. asset deal;

·???????? Seller’s role and compensation;

·???????? Potential financing contingency;

·???????? Due diligence process;

·???????? Exclusivity;

·???????? Deadlines for milestones;

·???????? Holdback obligations of the purchase price;

·???????? Allocation of the purchase price (accounting wise);

·???????? Covenants (what to do, and not to do, during the time prior final closing and signing LOI).

?

Concerning the purchase price, it is important to mention whether the working capital is included or not.

In most share deals (I am from The Netherlands) working capital is concluded, but then for a “normal level” (e.g. last year’s average).

A good definition can be taken up in the LOI, but most important components of working capital are account receivables, inventory and account payables.

Again, take some time to work out the exact definition of (net) working capital, and it’s average level.

?

For the rest, the following components are often included in the purchase price (with both a share deal and asset deal):

·???????? The operating assets needed for day to day business;

·???????? Covenant not to compete;

·???????? Name and website;

·???????? Business and financial records;

·???????? Trade secrets;

·???????? Licences and permits;

·???????? Assumption of product warranties.

Real estate and land is often dealt with separately.

?

Ideally the LOI should contain a list of milestones like:

·???????? The proposed closing date;

·???????? The expiration date of the due diligence;

·???????? Deadline for submitting the commitment letter from the lender;

·???????? Deadline for the first draft of the purchase agreement;

·???????? A deadline for signing the purchase agreement.

?

Best practices for sellers

With an eye on the seller, take the following issues into account:

·???????? Limit the exclusivity period;

·???????? Include milestones and deadlines;

·???????? End exclusivity when “re-trading” occurs.

?

Other components that can be take into account:

·???????? Allocation of the purchase price (this can have tax effects);

·???????? Legal form of the transaction (this will have a tax effect);

·???????? Escrow (holdback of the purchase price);

·???????? Representations & warranties (mentioned relatively “light” in the LOI);

·???????? Conditions/ contingencies;

·???????? Covenants;

·???????? The Seller’s role;

·???????? Termination on an LOI (e.g. break up fee).

?

With my deals, in most cases, the M&A lawyer will be involved when the LOI negotiations start.

Here the M&A advisor (corporate finance) will take care of the overall, and economic, issues in the LOI.

And the M&A lawyer will look at the legal aspects, this is a joint effort.

At last, of course a tax lawyer, or sometimes the house accountant, will be consulted for the tax issues.

Hope this gave you a better understanding of LOIs in M&A.

Best regards, Joris???

Kersten Corporate Finance

?