Knowing the different types of documents necessary for performing a business deal is crucial for success. One of the most common is a letter of intent (LOI). Understanding the meaning of the LOI is key to grasping the bigger picture of the deal. An LOI is typically used in mergers and acquisitions (M&A).
What Is a Letter of Intent?
A letter of intent is a nonbinding document which states the preliminary commitment that one company plans to perform a business transaction with a second company. It states the major terms of a prospective business deal. Upon first glance, an LOI may seem interchangeable with a term sheet, but there is a difference: an LOI is typically drafted in letter format, whereas a term sheet is typically in a list format. In most instances, a letter of intent to purchase is drafted by the legal department (or counsel) of a company.
What To Know About LOIs:
- Function: It states the commitment of one party to do business with a second party.
- Contents: It lists the important terms in a prospective business deal.
- Reason: It’s commonly used when two companies are negotiating the big-picture details of the transaction.
What Is Contained in an LOI?
As stated earlier, a letter of intent is indeed a letter, and is drafted in letter format. Because of that format, its sections should be written in an order that flows naturally and makes sense when read in the way it was written. Every letter of intent should contain the following sections:
- Introduction: This section states the purpose of the LOI, the date that it becomes effective and the definition of any terms that are necessary to the transaction.
- Parties: The buyer and the seller are clearly defined here, and a full description of both companies is given, especially the target company.
- Timing and transaction: This is the main section — it lists the terms and other important elements of the transaction, including prices and other costs. In addition, it outlines the timing (and deadlines) for the various steps of the deal.
- Contingencies: This is a road map of the deal; it details in which order certain steps must occur over the life of the transaction.
- Due diligence: Performing due diligence is a must in any M&A transaction; here, the buyer outlines what actions will be undertaken in the due diligence phase of the deal. Drafting this section can be the most complex (and time-consuming) part of the process, as it always contains both financial and legal items.
- Signatures: Needless to say, a signature (and date) field should always be included at the end of the document, along with the space for a notary stamp.
In addition, there are several other elements that are commonly included (but not always required) in an LOI, such as other financial elements (escrow, employee-held equity and options), legal issues (existing contracts, current legal proceedings) and other items such as exclusivity, current employees and even a quit clause (or termination conditions) for the transaction.
In short, a letter of intent should include all the key elements that are vital to any sort of business transaction.
What a LOI Isn’t
Understand that an LOI isn’t a legal, binding contract. It’s simply the first draft of the terms of a business deal, and is subject to revision — or rejection, for that matter. It contains only the outline for the actual deal, the ideas which the actual contract will be based upon. It’s typically not used in situations where a nonbinding document isn’t appropriate.
Keeping It Secure
Of course, a letter of intent, along with all the other documentation required for success, must be kept confidential yet be accessible to the parties who need to access it. In the past, achieving that was a tough job, as physical access to documents was required, and keeping the information out of the wrong hands was virtually impossible. Today, there is a solution to this conundrum: a virtual data room.
About Virtual Data Rooms
A virtual data room (VDR) is a vital tool for any company involved in an M&A. A VDR is a secure, online document storage location where companies can safely and securely store and share all the required documentation for an M&A, including a letter of intent. It provides cost savings and speed for any transaction by allowing all parties to share and edit documents quickly and securely.
How CapLinked Comes Into Play
As an industry leader in the VDR space, CapLinked delivers secure VDRs for any company involved in an M&A. We offer all the security features and functionality required, including secure access, enterprise-level encryption, multiple layers of security and version control. Its user-friendly interface allows easy uploading and editing of documents, and is compatible with virtually every operating system. To see how CapLinked can help streamline your M&A, try a free trial today.
Chris Capelle is a technology expert, writer and instructor. For over 25 years, he has worked in the publishing, advertising and consumer products industries.
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